Maryland’s digital ad tax may be a constitutional overreach

Intending to make Big Tech pay its fair share, Maryland has collected taxes on digital advertising revenue in the state. Critics say in a lawsuit that the tax can also generate revenue from the foreign state and that it is illegal.

The tax went into effect last month after the Maryland General Assembly voted to block Governor Larry Hogan’s veto. The law imposes gross income taxes on digital advertising services in Maryland.

The tax, unlike digital advertising revenue generated in Maryland, is distributed as follows:

• No tax for entities with a global gross income of less than $ 100 million;

• 2.5% for entities with global gross annual sales between US $ 100 million and the US $ 1 billion;

• 5.0% for rights with annual gross sales worldwide ranging from $ 1 billion to $ 5 billion;

• 7.5% for entities with global annual gross sales of more than $ 5 billion, up to $ 15 billion;

• 10.0% for entities with global gross annual sales in excess of $ 15 billion.

Industrial technology groups immediately filed a lawsuit to lower taxes. They cite several reasons why Maryland’s digital tax regulation is illegal, but most of their arguments are based on a common premise: that taxation is unacceptably harmful to trade between states.

Here are several legal reasons; We will focus on the most important: the latent exchange clause.

What’s in a condition?

According to the doctrine of the latent commercial clause (by the courts in Article 1, Article 8 of the United States Constitution), states cannot impose taxes that distinguish trade between countries. Some federal laws also prohibit this type of tax. For example, a state may levy an income tax on the income earned in that state, but it may not levy a consumption tax on businesses between countries.

However, discrimination between states is exactly how plaintiffs characterize the digital advertising tax in Maryland; they focus on the fact that tax rates are based on gross income earned worldwide, even if the basis is only to determine Maryland’s income.

The state tax based on gross income, rather than net income, is not automatically invalid (although it appears that at least two current members of the Supreme Court can do the opposite). However, many of these fees do not survive the investigation in the Supreme Court. Mathematically, it can be difficult for this tax to avoid taxes, which is a latent trade regime that is usually considered a serious sin.

An ongoing accident

To identify the type of double taxation that violates the latent commercial clause, the courts of the United States apply an “internal stability test” and an “external stability test”.

We simplify a lot.

Based on the internal stability test, a court decides what will happen if all other countries have exactly the same taxes as the countries concerned. If the same money were subject to more than one of these taxes, the tax would probably be unconstitutional.

The hypothetical nature of this test is generally irrelevant; even if no other state imposes such a tax, the mere risk of double taxation is a constitutional red flag.

The external stability test is broader and less hypothetical. Here the judge is limited to assessing the proportionality of the tax. It is not particularly scientific, but if the taxpayer can prove that the taxable profit is ‘disproportionate to what is being done in the state’, the tax is probably unconstitutional.

In the current case of Maryland, the risk of tax evasion is increasing due to the ‘global tax rate regime’. It seems theoretically possible that a company owes more than 100% of its profits from digital advertising in Maryland to the state of Maryland, even if the tax only covers Maryland’s income.

Extract excellent technology

In their lawsuit, plaintiffs cite the example of a hypothetical business that earns just over $ 15 billion in global gross annual sales (with a maximum digital advertising tax rate of 10%) – including $ 1 billion. In profits and 2% of all revenue and profits distributed to Maryland. As a result, the company makes a profit of $ 20 million in Maryland but has a tax base of $ 300 million under the Maryland Digital Advertising Tax Act.

Prosecutors note that Maryland will pay more than $ 1.65 million at the rate of 8.25%.

(Technically, this is a typo or miscalculation in the claimant’s report. The statements indicate the amount in your example exactly $ 15 billion. The maximum 10% tax rate for digital advertising does not apply. Gross annual income. Dollars for a value of the authors I absolutely intend to include, otherwise the tax rate for digital advertising would be 7.5%, but even with a lower rate, the multiple tax point would be less than ‘exactly $ 15.7, 5% would be digital, it would increase $ 22.5 million, even more than the $ 20 million paid out of Maryland’s revenue.

As it eliminates all profits for a Maryland company, it can pose an unconstitutional risk of tax increases between states.

In addition, it is not immediately clear to what extent the attorneys who advised the Maryland General Assembly have considered these issues. In several memoranda on this legislation, sent by the Maryland Attorney General’s Office, the latent issues of the trade clause were analyzed only from the perspective of IP monitoring transactions and not from a monetary review and evaluation.

To be fair, the actor’s example accepts proportional Capex and opex; Debates about how to distribute revenue to judge the constitutionality of state taxes can be confusing and plaintiffs bear the burden of proof. Time will tell whether the plaintiffs will achieve victory.

At the time of writing this report, the defendant (Maryland Department of the Treasury) had until April 16 to file a response to the lawsuit.

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