Digital Advertising Taxes and the States

David Stewart: 0:01

Welcome to the podcast. I'm David Stewart, editor in chief of Tax Notes Today International. This week: the state of state digital taxes. The subject of taxing online businesses has been discussed and debated at length at the international level for some time. So, it should come as no surprise that U.S. states have tried their hand in this as well. Most recently, the states have been tackling the subject of whether and how to impose taxes on digital advertising. Here to talk about this is Tax Notes reporter Carolina Vargas by phone from her home in Virginia. Carolina, welcome to the podcast.

Carolina Vargas: 0:38

Thanks, Dave.

David Stewart: 0:39

Up until now, how have states tried to tax the digital economy?

Carolina Vargas: 0:43

In the last several years, states have explored several ways to tax the digital economy. For example, many states have implemented ride-sharing fees for companies like Uber and Lyft. States have also started to tax short-term rentals like those available on home-sharing platforms like Airbnb.

David Stewart: 0:59

These new digital advertising taxes being proposed in several states are a bit different than what they've tried in the past. What are they and how do they work?

Carolina Vargas: 1:06

These tax proposals all vary, but they'd essentially be imposed on revenue from digital advertising services. For example, these can be the banner or search engine ads that market goods and services.

David Stewart: 1:18

All right. I understand that you interviewed someone about this. Could you tell listeners who you talked to and what they had to say?

Carolina Vargas: 1:23

I chatted with Roxanne Bland, contributing editor here at Tax Notes. We spoke about the states that have proposed legislation to enact digital advertising taxes and some of the controversies surrounding them. We also discussed how other states can make similar proposals, especially now that many are experiencing budget shortfalls due to COVID-19.

David Stewart: 1:42

All right, let's go to that interview.

Carolina Vargas: 1:44

Hi, and thanks for joining us on the podcast, Roxanne.

Roxanne Bland: 1:47

Thank you. Happy to be here.

Carolina Vargas: 1:49

Great. Well, let me just jump right in. What are digital advertising taxes and who do they impact?

Roxanne Bland: 1:55

Well, let's start with a definition of digital advertising. Digital advertising is pretty much what you think. It's promotional material that appears on a digital platform, whether that's social media, a website, or anything else digital. Like for example, if you're on Facebook and you see those Facebook ads, that's digital advertising. And the tax on digital advertising is generally either a gross receipts tax or it's a sales tax. So, there's no one real tax that a state can use. They can use either/or, or something else if they wish.

Carolina Vargas: 2:31

There's been a lot of controversies surrounding these tax proposals. What are some of the concerns and maybe some of the benefits?

Roxanne Bland: 2:38

The benefits, of course, is that the state raises real millions in revenue. That's really the benefit. The concern is that if states think they are going to pull in bucks from the big retailers, like Target or Walmart, something like that. Well, yes they will. But they're also going to pull in small, tiny retailers, one-person shop, that may be in their state. And by that, I mean, let's take the example of an author who is an independent author. He doesn't have a publishing company or anything like that. He sells through his own website. And this author puts up an ad on a website that is dedicated to readers. Well, that author would be subject to the digital ads tax and it's a one-person operation. And if you subject these small operations to the ads tax, any profit that they make could be wiped out. The state will take it. So, you're hurting your own people when you do that, your own in-state businesses. When a state imposes a digital ads tax with no carveout or de minimis or anything like that, everybody gets hit, and some suffer worse than others.

Carolina Vargas: 3:58

And those some are the small businesses.

Roxanne Bland: 4:01

Yes, those some are the small businesses.

Carolina Vargas: 4:03

Speaking of the states, there are three specific states-- Nebraska, Maryland, and New York-- that introduced legislation in January that would tax these digital ads. They all vary slightly in the way that they introduce legislation. Is there any right way to impose digital ad taxes?

Roxanne Bland: 4:22

That's a really good question. Whether or not there is a right way, I think is something that has to be figured out. Because we're talking about a process that is not like the process for print-- throw up a flyer, put an ad in the newspaper-- it's not the same. And one of the reasons why it's not the same, I think, is because you can tailor these ads to reach a specific particular audience, the audience who is most likely going to buy your product. It's not like a newspaper. The newspaper delivers to everybody. And of course not everybody's going to be interested. I think it's a different animal than what most advertising, if you will, if it's taxed at all, are used to. It's kind of like when the hotel intermediaries, the Expedias, and so on and so forth, came into being. The problem was not that they should not be subject to tax. The problem was that the states' tax laws didn't cover this type of business entity. And I think that's might be pretty much the problem here. Whether there's a right way, I think is something that's going to have to be thought through carefully. So that it's fair to everyone and it's workable. And that's a big deal. Whether or not these taxes because of the way they are presented on a digital platform. Are they workable? Here's an example. Let's take our author again. In fact, let's take our author and Maryland, the Maryland legislation. The Maryland legislation at first said you would trace the person who's placing the ad through their IP address. The second version basically said the same thing, but then you can use other factors to figure out whether this person's in Maryland. Well, if an author is selling his books by himself and is using a VPN, the author may not be in Maryland as far as they can tell. A VPN server can be anywhere in the world. So, how would you know if your author is in Maryland? And that's one thing. The second thing is, let's say our author is selling print, bu t-- and this would really only apply to print books-- but let's say our author is selling print books from his website and orders a print run. And when you go to a printer and order a print run, it's usually 5,000 books. So our author has the books printed and stores them in his garage. And every time a customer orders, the author sends out a book. Now, the author is sending out a book from his home or office address or whatever. That office address is in Maryland and there's a record. OK? If the author is using a print-on-demand service, that's something else entirely. Amazon has a print-on-demand service. The customer goes to Amazon, buys the book. Amazon prints the book and sends it to the customer. The author doesn't do a thing. I don't know where Amazon's printing facilities are, but I'm pretty sure they're not in Maryland. So, how do you know where the author is? That's the kind of thing I'm talking about. There are ins and outs to this that I don't think state legislatures-- or at least the three that have proposed legislation-- there are things that they just haven't thought through. And I think that's what they have to do. And I think that's what they have to do in order to find the right way, if there is one.

Carolina Vargas: 7:41

And Maryland's governor did veto that bill. So, you're saying that they would be best advised if they decide to reintroduce this legislation to explore all these challenges, correct?

Roxanne Bland: 7:55

Maryland is in a bit of a position because the bill, as it was passed by the Assembly and the Senat,e is veto proof. Both houses garnered enough votes, so that if the governor vetoes the bill, they can pass it anyway. So, they obviously, because of the pandemic, they didn't call a special session and it would be handled at the regular session that starts in January 2021. And of course, who knows what's going to happen? I mean, with the pandemic, it's flat, it's up, it's flat. Will there be an in-person 2021 session? Really, nobody knows. So I'm not sure what's going to happen with the bill. Other than to say that it can be passed as it stands without the governor's signature.

Carolina Vargas: 8:41

Can we expect to see similar legislation being proposed in other states? You mentioned the pandemic. A lot of states are in a position that they need revenue. Could this be a way to get to it?

Roxanne Bland: 8:53

Well, yes, depending on how legislative sessions end up going. I would think that more states will try to introduce such legislation because yes, they need the money. They need it bad. However, I also think that states, like I said before, they really need to think about how they're going to do this in order to make it work. Also, I think there may be some lag because states might want to see how it pans out in other states like Nebraska, Maryland, and New York-- to see how it pans out. There are also constitutional issues. There's the Permanent Internet Tax Freedom Act that you have to get around. I mean, regardless of the constitutional issues, there's PITFA, and PITFA says you cannot tax anything that's an electronic commerce, whether it's a good or service or whatever unless there is a physical counterpart that's taxed. Then you can tax the electronic counterpart. But if there's no physical counterpart, then you can't tax the electronic version. And I think this is probably the problem. I mean, I haven't studied the bill, but I think this will be Nebraska's problem. Nebraska wants to tax digital advertising, but they don't tax print advertising. So under PITFA, they couldn't do it anyway. So it's kind of a long shot. But the only way I could think of that a state might get away with taxing digital advertising is if the digital advertiser doesn't have a print version, it's just digital. Because you could possibly make a classification that we have a digital-only medium. And then over here we have a dual medium. So if the legislature can get away with making that classification, that would be an equal protection issue mainly. But if they could get away with that classification, then you could say for the digital-only medium that,"Well, you don't have a print counterpart." So if the state imposes a tax on the medium that doesn't have a print counterpart, you avoid PITFA. I mean, I think a lot of people would say that's dubious, but this type of argument has been successful in other contexts. There's a case called ANR Pipeline-- I think it's out of Kansas, which I think is in the Tenth Circuit-- where the pipeline brought suit against the department because they were being taxed differently than the railroad, which under the state scheme, they were basically the same category. And the court said that,"Yes, the state is taxing you differently. And yes, the state may even be discriminating against you. However, the state is doing what it's doing because of the federal law. They have to do it this way. And so since they have to do it this way by law, it's not the same type of discrimination that would otherwise exist." So what I'm thinking is that, well, if you have a dual medium that you have to leave alone because of PITFA, then a digital-only medium, you might get away with it. It's a long-shot argument. And actually it's only been accepted by the Tenth Circuit as far as I know. So, you'd have a job convincing other courts to accept it. But it's there.

Carolina Vargas: 12:01

Well, given these challenges, if any of these tax proposals in these three states are enacted, what would enforcement look like?

Roxanne Bland: 12:10

That's a good guess. I'm not an auditor or anything like that. But this goes back to my example with Maryland. Now, a big corporation, yeah, I'm sure they would have some kind of an audit trail or something like that. But a small business? No, they wouldn't. I mean, it's very doubtful that they would, if they're doing everything by themselves. I mean, they may have electronic receipts and things like that, but, you know, you're talking about a situation where for some businesses, it might be more trouble than it's worth to collect. So therefore I think whatever they've done, they might want to carve out a de minimis limit.

Carolina Vargas: 12:46

Great. It's been a pleasure speaking with you today.

Roxanne Bland: 12:49

Thank you. It's been a pleasure being here.

David Stewart: 12:52

And now coming attractions. Each week, we highlight new and interesting commentary in our magazines. Joining me now from her home is Acquisitions and Engagement Editor in Chief Faye McCray. Faye, what will you have for us?

Faye McCray: 13:02

Thanks, Dave. In Tax Notes Federal, Natasha Sarin and Lawrence Summers describe why increased IRS funding would increase tax revenue. Three practitioners from PwC examine the foreign-derived intangible income regime. In Tax Notes State, Stephen Kranz and Lauren Ferrante cite examples of why applying canons of statutory construction in state tax cases should not be a rote, automatic exercise by courts. Four practitioners from Eversheds Sutherland discuss why taxpayers should think twice about a"file and refund claim" strategy. In Tax Notes International, Steve Suarez presents an in-depth tax guide on doing business in Canada for multinational enterprises. Torsten Fensby argues that the OECD's two-pillar approach to digital taxation would prove harmful to the Swedish economy. And on the Opinions page, Benjamin Willis and William Alexander discuss tax guidance and step transaction. Nana Ama Sarfo talks with Virginia La Torre Jeker about establishing her tax practice abroad, the challenge of balancing family life with career, and recent international tax issues. Roxanne Bland discusses the controversial issue of whether a legislature should have the power to enact retroactive tax legislation.

David Stewart: 14:20

You can read all that and a lot more in the pages of Tax Notes Federal, State, and International. That's it for this week. You can follow me online@TaxStew, that's S-T-E-W. And be sure to follow@TaxNotes for all things tax. If you have any comments, questions, or suggestions for a future episode, you can email us at podcast@taxanalysts.org. And as always, if you like what we're doing here, please leave a rating or review wherever you download this podcast. We'll be back next week with another episode of Tax Notes Talk.