In an era of ever-expanding state tax bases, there are two new legislative proposals in Maryland (SB 2) and Nebraska (LB 989) that seek to either extend a current tax base (in the case of Nebraska, the sales tax base) or create a new tax (in the case of Maryland) to capture digital advertising revenues. The Maryland tax also signals a continued trend toward nuanced gross-receipts-type taxes. If a tax targeting digital advertising services sounds familiar, that is because the Ohio Department of Taxation attempted to extend the Ohio sales tax to digital advertising services in 2016 (though this extension was rejected by the Ohio Legislature’s enactment of an exemption from the sales tax for digital advertising services later that same year).

Nebraska’s current proposal seeks to expand the sales tax base to include the “retail sale of digital advertisements.” The bill then goes on to define “digital advertisements” as “an advertising message delivered over the Internet that markets or promotes a particular good, service, or political candidate or message.” The Nebraska bill leaves much to be desired in terms of both the clarity of the tax imposition as well as efficient or effective administration of the tax. For example, as written, it appears that the tax is limited to the sale of advertisements as opposed to the sale of advertising services. If limited to advertisements, how does a taxpayer determine the appropriate sales sourcing? Is it the location of the customer that pays for the advertisement? Is it the location of delivery of the final advertising product (for example, where an advertisement is produced and delivered to the customer for ultimate distribution through another means)? Is it the location of viewers of the advertisement and, if it is the location of the viewers, how is that location determined? What is the impact if an advertising agency is involved?

Maryland’s current proposal marches to a completely different beat by imposing an entirely new gross receipts tax (separate from its current business taxes) on “digital advertising services.” Specifically, “a tax is imposed on the annual gross revenues of a person derived from digital advertising services in [Maryland].” Annual gross revenues are defined as “income or revenue from all sources, before any expenses or taxes, computed according to generally accepted accounting principles.” (emphasis added). For purposes of the Maryland proposal, “digital advertising services” are defined to include “advertisement services on a digital interface, including advertisements in the form of banner advertising, search engine advertising, interstitial advertising and other comparable advertising services.” Interestingly, by using the words and phrases “includes” and “other comparable advertising services,” the proposal leaves room for judgement to be applied in expanding the tax base. A “digital interface” means “any type of software, including a website, or application, that a user is able to access.” To determine whether revenues from digital advertising services are derived from within Maryland, the proposal determines that such services are provided within Maryland when the digital advertising services appear on the device of a user (1) with an internet protocol address that indicates that the user’s device is located in the state, or (2) who is known or reasonably suspected to be using the device in the state. For taxpayers that do not have IP address information and are in the second category of users described, the “reasonably suspected” language is quite troubling. How can a taxpayer be reasonably expected to know where someone is actually viewing a particular display ad on their device, let alone where some is “reasonably suspected” to be using their device? How is such a provision to be administered or enforced?

Finally, in the Maryland proposal, the rate of tax is based on an entity’s annual global gross revenue from advertising services – not Maryland revenue. The tax rate ranges from 2.5 (for companies with 100 million or more in annual gross revenue) to 10 percent (for companies with 15 billion or more in annual gross revenue). By using global gross revenues for purposes of the tax rate, questions arise under the Commerce Clause regarding discrimination against foreign commerce.

Although the Maryland tax may suffer from several infirmities (as discussed above), a key question may also involve nexus. While Wayfair has made it clear that physical presence is no longer required for sales tax purposes and many have argued that this rule should also apply in the business activity tax (including the gross receipts tax) context, there is question as to whether a company may be taxed solely because the advertisements it creates may be viewed by someone in Maryland who is not even the taxpayer’s source of revenue (so, not its customer). Indeed, is this “substantial economic presence” as the Supreme Court intended in Wayfair? Such an imposition may also raise nexus questions under the Due Process Clause.

Finally, and perhaps most importantly, neither Maryland nor Nebraska appear to impose similar taxes on non-digital advertisements or advertising services which would appear to be in clear violation of the Internet Tax Freedom Act (ITFA), which prohibits discriminatory treatment of e-commerce. ITFA is becoming more and more important as a tool for taxpayers to ensure that new tax impositions do not fall disproportionately on digital goods and services.

The digital advertising proposals in Maryland and Nebraska leave much to be desired. Taxpayers should carefully review and consider the proposals, including the Constitutional, ITFA, and other issues discussed herein, and should seek to either modify these proposals to address these issues or to defeat these proposals. After Wayfair, an expansion of sales and use tax bases may have been expected; however, states must be reminded that any enactments should not only be consistent with the U.S. Constitution and federal law but also with sound reason and tax policy.