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Taking Cues From Other Countries, States Target Big Tech With Taxes

Posted on Mar. 24, 2021

State lawmakers are taking cues from other countries by taking aim at Big Tech with taxes, but the novel proposals face legal hurdles and pushback from some of the world’s most powerful companies.

Maryland recently became the first state to adopt a gross revenues tax on digital advertising services after the General Assembly overrode Republican Gov. Larry Hogan’s veto of the bill, despite lobbying by a coalition of more than 200 businesses to sustain the governor’s veto.

Less than a week after the controversial tax was adopted, a lawsuit was filed in federal court by the U.S. Chamber of Commerce, the Internet Association, and two other trade associations.

Opponents of the tax argue it's unconstitutional. But proponents are confident the tax will withstand legal scrutiny.

The Maryland digital advertising tax is just one example of states trying to update tax regimes to keep up with the digital economy.

Maryland’s tax and other state proposals are modeled after similar digital services taxes in other countries, some of which have been under investigation by the U.S. government for potential discrimination against U.S. companies.

Austria implemented a 5 percent digital advertising tax last year, which applies to large companies with annual worldwide revenues of at least €750 million, with a minimum of €25 million of those sales connected to digital advertising sales in Austria. And the United Kingdom adopted a broader DST last year that applies to the U.K. revenues of large corporate groups that offer social media services, search engines, or online marketplaces.

Poland is also planning a tax on digital advertising to fund health services for coronavirus recovery and other priorities and will base it on taxes levied in Austria, France, Spain, India, Italy, and the United Kingdom.

The European Union attempted to pass an EU-wide tax in 2019 and is now exploring a “digital levy” if countries can’t agree on a global tax reform plan to tax digital activity.

Adam Thimmesch, professor of tax law at the University of Nebraska-Lincoln, told Tax Notes that states are grappling with how to address economic and social issues stemming from the effects on society of digital platforms. 

Thimmesch said that under neutral tax principles, it's problematic that businesses involved in digital advertising are operating under different rules than those operating in more traditional formats. “It seems perfectly reasonable for states to think about how to better address that,” he said.

However, Marc Simonetti of Pillsbury Winthrop Shaw Pittman LLP likened Maryland’s digital ad tax to a sin tax that he said would be “over the top” because it would be in addition to the regular income tax.

Noting that sin taxes are meant to curb unhealthy behaviors like smoking and gambling, Simonetti said there is a question whether social media and Big Tech are bad for society.

“I haven’t seen anyone suggest that or any sort of study suggesting that there is a drain on society, and I don’t think I’ve seen any sort of corrective measure that’s been talked about being funded,” he said.

Thimmesch questioned whether the companies are being subjected to state corporate income taxes.

“I don’t know that I’ve seen any real confirmation that all these companies are . . . subject to the state corporate income tax across the country. States certainly have the ability to do that. They could be imposing corporate income tax on these companies, so to the extent that they are, that is a legitimate question. Is that enough? And an additional tax looks more discriminatory,” he said.

Legal Barriers

Proposals to tax the tech industry are expected to face significant challenges. 

“Anyone who is worried about the tech industry can be confident that legal challenges to this tax will be robustly pursued," Simonetti said. 

Some legal experts say the First Amendment could be a barrier to states trying to tax digital advertising.

Simonetti noted that while European countries don't have First Amendment protections on free speech to consider when taxing digital advertising, the United States does.

He pointed to McGraw-Hill Inc. v. State Tax Commission, in which the New York Court of Appeals held that a franchise tax on advertising receipts violated the First Amendment. “This isn’t really different than what happened in the McGraw-Hill case,” he said.

Legal experts have argued that the Permanent Internet Tax Freedom Act (PITFA), which prevents states from imposing multiple and discriminatory taxes on electronic commerce, is the biggest hurdle for Maryland’s new law. Opponents have also argued that the tax violates the due process and commerce clauses of the U.S. Constitution.

Thimmesch said he thinks PITFA is a significant barrier to taxing digital advertising to the extent that states are singling out activities that take place electronically.

“There is a real issue with that, and that is a tough one for states to grapple with. I think that is going to, in the short term, prevent states . . . from acting, and it’s already complicated the efforts in Maryland,” Thimmesch said.

Ruth Mason, a professor of law and taxation at the University of Virginia, said it's important for states wanting to tax these companies not to discriminate.

Mason believes the revenue threshold in Maryland's law could raise a foreign dormant commerce clause issue. The tax applies to companies making more than $100 million in global annual gross revenue, which Mason said could discriminate against out-of-state businesses. That concern could be eliminated if the state lowered the revenue threshold to include Maryland-based companies, she said.

“They would not, however, get rid of their Internet Tax Freedom Act problem,” Mason said. “If they apply the same kind of tax they’re applying to digital companies also to print ads, they get rid of that discrimination.”

Despite the litigation over Maryland’s law, proposals have been introduced in other states.

Shortly after the Maryland tax was adopted, two digital ad tax bills were introduced in Massachusetts. 

H. 3210, introduced February 18 by Rep. Erika Uyterhoeven (D) and Sen. Adam G. Hinds (D), would establish a gross revenue tax on the assessable base of in-state ad revenue for companies with annual gross revenue of at least $50 million.

The tax would be levied at 5 percent of the assessable base of in-state ad revenue for companies with annual gross revenue of $50 million through $100 million; 10 percent for companies with revenue over $100 million through $200 million; and 15 percent for companies with revenue over $200 million.

And a bill introduced February 19 by Massachusetts Rep. Dylan A. Fernandes (D), H. 3601, would establish a 5 percent tax on the annual revenue from digital advertising services for companies with more than $25 million per year in digital advertising services sales within the state. The revenues would be used to provide support for local newspapers and universal prekindergarten, early education and care programs, and child care programs.

In Connecticut, legislators are considering two digital advertising tax proposals. One was offered by Rep. Holly Cheeseman (R), ranking member of the taxwriting committee, and another was proposed as part of a progressive tax reform plan sponsored by more than 30 Democrats.

More recently, bills have been introduced in West Virginia and Texas. Proposals are also being considered in New York and Montana.

Unlike Maryland’s gross receipts tax, a bill introduced in Arkansas would impose a 7 percent sales tax on gross revenue from social media advertising services in the state.

Other Taxes

Beyond controversial digital advertising taxes, many states have already expanded their sales and use tax to digital products.

Maryland expanded its sales and use tax to digital products on the same day it adopted the digital ad tax.

Other bills have been introduced in New York, West Virginia, and Washington that would tax data mining or data processing. 

The Washington bill (H.B. 1303) would establish a new 1.8 percent business and occupation tax for the sale or exchange of personal information and would exempt the sale of personal information from sales and use taxes.

The bill's sponsor, Rep. Shelley Kloba (D), told Tax Notes March 10 that “the data being collected and sold and monetized is a segment of our economy that is viable and is not going away. It is an activity that is making money off of Washingtonians, but we’re not getting any state revenue from it.”

Kloba said her bill would create a registry of the firms collecting data. The bill is scheduled for a hearing March 23 in the House Committee on Finance.

Simonetti said that although the data mining proposals appear to be unsophisticated, he thinks they could be the next trend. “Data mining, I think, is the other element that those Big Tech companies have that is unique to them; that allows them to generate substantial revenue,” he said.

Andrew Appleby, assistant professor of law at Stetson University, said in a recent paper that if a jurisdiction’s main motivation is to tax the value associated with collecting user data, a tax on data collection is the best way to update its tax structure.

Appleby said there are many difficulties associated with imposing a new data mining tax regime. "With any tax regime, especially one involving the digital economy, sourcing is incredibly difficult," he said. "Depending on how the tax regime is designed, there may be several constitutional infirmities."

"But one way in which data mining taxes are less problematic than digital advertising taxes is that it is easier, politically and practically, to impose the tax uniformly regardless of whether the activity is effectuated through digital or traditional means. Doing so would mitigate the [PITFA] preemption issues that many of these early digital advertising tax proposals are facing," he said. 

Simonetti said that if the Maryland tax is struck down, as he expects it to be, states may pursue taxes on data collection or try to overturn PITFA.

Mason said an argument has been made that “[PITFA] itself may have a constitutional infirmity that it may represent unconstitutional commandeering by the federal government of the states, and that argument is . . . a little more out there.”

However, Mason noted that the U.S. Supreme Court’s 2018 majority opinion in Murphy v. National Collegiate Athletic Association, a case involving the federal Professional and Amateur Sports Protection Act, raised the potential issue of commandeering.

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