On Friday, Maryland became the first U.S. state to impose a tax on digital advertising revenues, overriding its governor’s earlier veto and setting the stage for a heated battle with numerous big tech companies (Google, Facebook and Amazon, among many others) that are sure to contest imposition of the tax. The bill levies a state tax of up to 10% on gross revenues from digital advertising aimed at users in Maryland. Proceeds from the new tax are explicitly earmarked for a fund dedicated to improving Maryland public schools.

The Maryland legislation defines “digital advertising services” to include advertisement services on a “digital interface,” including “banner advertising, search engine advertising, interstitial advertising and other comparable advertising services.” A “digital interface” is defined as "any type of software, including a website, part of a website, or application, that a user is able to access,” and a “user” is defined as “an individual or any other person who accesses a digital interface with a device.” Entities with global (not just Maryland or US) annual gross revenues (from all sources, not just advertising revenues) of less than $100 million are exempt (although Maryland digital advertising revenues exceeding $1 million triggers a tax return filing requirement). The applicable tax rate is 2.5% for businesses with global annual gross revenues of $100 million - $1 billion, 5% for businesses with global annual gross revenues of $1 billion - $5 billion, 7.5% for businesses with global annual gross revenues of $5 billion - $15 billion and 10% for businesses with global annual gross revenues in excess of $15 billion. For instance, a company subject to the 10% rate having $100 million of digital advertising revenue attributable to Maryland would owe a tax of $10 million.

The most interesting question posed by Maryland’s newly-adopted tax may be how to determine the portion of a business’ digital advertising revenues that is attributable to Maryland. The legislation requires the application of an apportionment fraction comparing the amount of the business’ annual gross revenues derived from digital advertising services in Maryland relative to such business’ annual gross revenues derived from digital advertising services in the U.S., and directs the Comptroller of Maryland to adopt regulations that “determine the state from which revenues from digital advertising services are derived.” This latter provision of the Maryland legislation may be its most critical, as it punts what may its thorniest implementation question to the Maryland Comptroller. Will apportionment be based on Maryland’s population relative to that of the U.S. as a whole, on the number of devices in Maryland relative to the U.S. as a whole, on the number of Maryland-linked IP addresses relative to the U.S. as a whole or perhaps another metric or metrics? The answer to that question may have ramifications not only for Maryland’s tax on digital advertising services, but on similar taxes being considered by other states (including New York), as well as other state and local taxes and even U.S. federal and foreign taxes that involve the imposition of taxes on revenues or income derived from digital transactions where source, origin or destination is not always clear.

The Maryland bill’s effective date is July 1, 2020, but is “applicable to all taxable years beginning after December 31, 2020,” Under the Maryland Constitution, vetoed legislation becomes effective on the later of the effective date in the bill or 30 days after the veto is overridden. Based on Friday’s veto override, the bill should become effective on or about March 14, 2021, but may be retroactive to the beginning of 2021.  That may become another source of contention for opponents of the bill.

Even before its passage, Maryland’s digital advertising services tax encountered heavy opposition, and now with its passage, the battle to overturn it is sure to be waged on a number of fronts, including arguments that it violates the Internet Tax Freedom Act, a federal law which prohibits discriminatory taxes on electronic commerce, that it fails a Dormant Commerce Clause analysis under the U.S. Constitution by setting rates based on the worldwide gross revenues of advertising platforms -- economic activity that has nothing to do with Maryland, that the economic impact of the tax will be felt not by the advertising platform companies, but by the advertisers to which the economic burden of the tax will simply be passed along and that it will disproportionately harm Maryland businesses.  In short, the opening shot in the war on digital advertising services taxes has now been fired and the battle has begun.