This transcript has been edited for length and clarity.

David D. Stewart: Welcome to the podcast. I'm David Stewart, editor in chief of Tax Notes Today International. This week: getting crabby about digital ad taxes.

As governments around the world continue to grapple with the tax implications of the digitalization of the economy, so do governments here in the United States. We've previously talked about Maryland's digital advertising tax in 2021, and you can find those episodes linked in the show notes.

Now since our last update, some things have happened. So here to talk about where we stand now is Tax Notes senior legal reporter Andrea Muse.

Andrea, welcome back to the podcast.

Andrea Muse: Thanks, Dave. Glad to be back.

David D. Stewart: Could you start us off with some background of the issue we're talking about here?

Andrea Muse: Sure, so the tax is actually the first of its kind. It's on digital advertising revenue attributable to Maryland, but it's imposed on businesses with total global revenues of over $100 million dollars. The rate varies from 2.5 percent to 10 percent based on those total global revenues. It was enacted early in 2021 for tax year 2022. Their estimated payments were being made beginning in 2022, but the first actual return wasn't due until April of 2023.

David D. Stewart: OK. Now this tax hasn't been without controversy, and there's been a challenge to it, so can you tell me about that case?

Andrea Muse: Sure. There's been actually two challenges. One is in the state court, and that's by Comcast and Verizon. They challenge in the Anne Arundel County Circuit Court. And they argued that the tax was unconstitutional — that it violates the commerce clause by discriminating against interstate commerce.

One thing about this tax is that because it's for businesses with such large revenues, it only impacts, I believe they said, 10 to 12 companies. And they also argued that it violates the First Amendment. Their challenge is there is an amendment adding an exemption for broadcast entities, and the companies argue that that targets speech.

And then they also argue that [it] violates the Internet Tax Freedom Act because the tax is solely on a product of electronic commerce, digital advertising, and the state is not taxing traditional advertising.

David D. Stewart: All right, so how did that case progress?

Andrea Muse: So at the circuit court level in October 2022, the judge actually agreed with Comcast and Verizon that the tax was unconstitutional. The state had mainly argued that the companies had not exhausted their administrative remedies. They had filed directly in circuit court versus going through the administrative process of challenging an assessment or paying a tax and seeking a refund. The [state] also argued that the tax was constitutional.

The companies said that they actually met a constitutional exception since they were facilely challenging the tax and the entirety of the law being unconstitutional. The judge agreed with the companies that they met this exception, allowed the case to go forward, and ultimately struck down the tax. Well, it was a declaratory judgment, and she declared that the tax was unconstitutional.

The state appealed, [so] it went to the newly named Maryland Supreme Court — there's been an intervening name change of their court systems — and the Maryland Supreme Court had briefing [from the parties] and then held oral arguments on May 5.

The oral arguments were interesting because the justices very much focused on the exhaustion of administrative remedies issue. There was not much discussion on whether or not the tax was constitutional. [On] May 9, they issued an order saying that the circuit court lacked jurisdiction to hear the case and ordered the case be dismissed, finding that the companies were required to exhaust all administrative remedies.

It is just an order. The order does say that the court will be releasing an opinion later on setting out their reasons. We have not seen that opinion yet. Don't know that there's been any discussion, any news, about when that opinion would actually be filed.

David D. Stewart: Where do things stand now then? Where do the parties go from here?

Andrea Muse: I think, honestly, they will probably be waiting for the opinion to see if there's going to be next steps as far as an appeal. But at the end of the day, I think that this means that for tax figures, they are going to have to go through the administrative process.

One thing here was when this suit was filed in 2021, because the return wasn't due until 2023, there really was no way, at least the companies were alleging, to even participate in the administrative process.

Now, at least with the April 17 date being passed [when the first return was due], there is potentially a place to pay the tax file, the return, and now either seek a refund or challenge an assessment and go through the administrative process.

That, of course, will probably take some time.

David D. Stewart: OK. Now, you said earlier that this was one of the cases challenging this tax. Could you tell us about the other one?

Andrea Muse: Yes. So several associations, including the U.S. Chamber of Commerce, also sued alleging that the tax was unconstitutional, but in federal court. In that case, the federal district judge actually dismissed most of the challenge under the Tax Injunction Act, finding that there is a plain, efficient, and speedy remedy in state court.

The federal judge there, however, allowed their First Amendment challenge to proceed. Now, their First Amendment challenge is slightly different than the companies'. The associations are arguing that the provision in the law prohibiting companies from directly passing the tax on to customers as a separate charge on the bill violates their First Amendment right.

So the judge allowed — initially when she dismissed the other charges — she allowed that one to proceed. But once the circuit court issued its ruling that the tax was unconstitutional, she dismissed that count as moot without prejudice, noting that the circuit court could be overruled on appeal, in which case the case could be live.

The associations then appealed to the Fourth Circuit. That's where the case is pending now. Briefing was finished mid-March. They asked for the case to be accelerated. That was denied in January, and the Fourth Circuit, in that same order, deferred scheduling oral arguments. So that case is probably waiting for what happens with the state.

Now that there's been an order, I don't know if we'll see movement in that case as well.

David D. Stewart: OK. What is the broader context of these cases? What are the issues that we're dealing with here?

Andrea Muse: So one thing is that this really is the first of its kind. I don't know that there's ever been a new tax that's solely on a digital product or service. Certainly there's been instances where existing taxes have been applied, or have been attempted to be applied, to digital products and services.

But as far as a new tax solely on a portion of electronic commerce, I believe this is fairly unique for the United States. There's also interest in the unique structure of the rate where even though the tax itself is on revenues attributable to Maryland, the rate is based on global revenues — total global revenues, not just digital advertising, but all of the revenues of a business and from everywhere. So there have certainly been some concerns about discrimination against interstate commerce there.

Here, certainly there has been interest in other states in passing similar taxes. So far, no state has enacted a tax. Probably they're waiting to see what happens to Maryland. These challenges were pretty certain to happen, and so people, I think, have been waiting.

One thing now, if it looks like they might be waiting for a couple of more years, you might see more states deciding to just try their luck and actually pass similar taxes.

David D. Stewart: What sort of things are you hearing from people for or against this tax?

Andrea Muse: I think there's been strong commentary on both sides. There was an amicus brief filed by five tax law professors who noted that the rate structure is used in progressive income taxes as well with some income taxes being based — the income tax itself being imposed on an individual's income in that state — but the rate itself being based on their income everywhere.

You also have seen a lot of commentary about the law itself, with people concerned with how broad the language was and the fact that it seemed that the legislature was relying on the comptroller to set out exact definitions of say, what would be in the tax base.

The other thing, even more broadly, is the fact that this tax is in tension with the federal government, who has criticized foreign countries for attempting to enact national level digital service taxes. Especially if there are more states [that] start to enact these kinds of taxes, how does that look with a federal government that maybe is critical of similar taxes in international spaces?

David D. Stewart: All right. This has been excellent, and thank you for coming, and we'll definitely have to talk again when we have more court outcomes to discuss.

Andrea Muse: Definitely.

David D. Stewart: And now, coming attractions. Each week, we highlight new and interesting commentary in our magazines. Joining me now is Acquisitions and Engagement Editor in Chief Paige Jones. Paige, what will you have for us?

Paige Jones: Thanks, Dave. In Tax Notes Federal, three tax pros explore different arguments for and against the taxation of gifts of luxury hospitality. Brian Elzweig and Valrie Chambers examine the tax issues of fractional NFTs.

In Tax Notes State, four SALT attorneys with Bass, Berry & Sims review how two appellate court cases and recent administrative updates and legislative developments have affected the Tennessee business tax. In the latest installment of The Search for Tax Justice column, Avery Hederman and [V.] Brooks Poole argue for creating a more equitable tax code for Americans with disabilities.

In Tax Notes International, Mindy Herzfeld examines whether the OECD's two-pillar agreement can deliver its promise of international tax stability when countries such as Australia take unilateral actions that undermine conformity. Five tax pros provide a comprehensive overview of the UTPR, examining the rule's compatibility with international law from three different legal angles: customary international law, tax treaties, and EU primary law.

And finally, in Featured Analysis, Nana Ama Sarfo reviews the European Business Tax Forum's latest total tax contribution study, which argues that multinationals may need to play a larger role in driving carbon tax policy.

David D. Stewart: 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 feature 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.

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