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Interview: Digital Advertising Taxes and the States

Posted on July 20, 2020

Tax Notes reporter Carolina Vargas interviews Tax Notes State contributing editor Roxanne Bland about the emerging trend among some states to tax digital advertising.

This post has been edited for length and clarity.

Carolina Vargas: Thanks for joining us on the podcast, Roxanne.

Roxanne Bland: Thank you. Happy to be here.

Carolina Vargas: What are digital advertising taxes and who do they impact?

Roxanne Bland: 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. For example, if you're on Facebook and you see those Facebook ads, that's digital advertising.

The tax on digital advertising is generally either a gross receipts tax or a sales tax. There's no one real tax that a state can use. They can use either/or, or something else if they wish.

Carolina Vargas: 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: The benefit, of course, is that the state raises millions in revenue. The concern is that if states think they are going to pull in major bucks from the big retailers like Target or Walmart, they're also going to pull in small, tiny retailers and one-person shops that may be in their state.

Let's take the example of an independent author who doesn't have a publishing company or anything like that. He sells through his own website. This author puts up an ad on a website that is dedicated to readers. That author would be subject to the digital ads tax.

If you subject these small operations to the ads tax, any profit that they make could be wiped out. The state will take it. You're hurting your own in-state businesses when you do that. When a state imposes a digital ads tax with no carveout or de minimis, everybody gets hit and some suffer worse than others.

Carolina Vargas: 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: That's a really good question. Whether or not there is a right way is something that has to be figured out. We're talking about a process that is not like the process for print where you throw up a flyer or put an ad in the newspaper. It's not the same.

One of the reasons why it's not the same, I think, is because you can tailor these ads to reach a specific audience: those most likely to buy your product. It's not like a newspaper, which is delivered to everybody. I think it's a different animal than what most advertising, if it's taxed at all, is used to.

It's kind of like when the hotel intermediaries like Expedia came into being. The problem was not that they should not be subject to tax. The problem was that the state tax laws didn't cover this type of business entity. I think that might be pretty much the problem here.

Whether there's a right way is something that's going to have to be thought through carefully. It has to be fair to everyone and workable. But are they workable?

Here's an example. Let's take our author again. Let's say he's in Maryland. The Maryland digital advertising tax 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 avirtual private network (VPN), the author may not be in Maryland as far as they can tell. A VPN server can be anywhere in the world. How would you know if your author is in Maryland? That's one thing.

The second thing is, let's say our author is selling print   and this would really only apply to print books   and is selling print books from his website and orders a print run. When you go to a printer and order a print run, it's usually 5,000 books. Our author has the books printed and stores them in his garage. Every time a customer orders, the author sends out a book. The author is sending out a book from his office in Maryland and there's a record. 

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 and 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. 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   have thought through. I think that's what they have to do in order to find the right way, if there is one.

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

Roxanne Bland: Maryland is in a bit of a position because the bill, as it was passed by the Assembly and the Senate, is veto proof. Both houses garnered enough votes so that if the governor vetoes the bill, they can pass it anyway. Because of the pandemic, they didn't call a special session. It would be handled at the regular session that starts in January 2021.

Of course, who knows what's going to happen with the pandemic? Will there be an in-person 2021 session? Nobody really knows. 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: Can we expect to see similar legislation being proposed in other states? A lot of states are in a position that they need revenue as a result of the pandemic. Could this be a way to get to it?

Roxanne Bland: Yes, depending on how legislative sessions end up going. I would think that more states will try to introduce such legislation because they need the money.

However, I also think that states 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.

There are also constitutional issues. There's the Permanent Internet Tax Freedom Act (PITFA) that you have to get around. I mean, regardless of the constitutional issues, there's PITFA, which says you cannot tax anything that's an electronic commerce, whether it's a good or service, 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.

I think this is probably the problem. 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. Under PITFA, they couldn't do it anyway. It's kind of a long shot.

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. You could possibly make a classification that we have a digital-only medium. 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."

If the state imposes a tax on the medium that doesn't have a print counterpart, you avoid PITFA. 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. The court said that, "Yes, the state is taxing you differently. 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. Since they have to do it this way by law, it's not the same type of discrimination that would otherwise exist."

I'm thinking that 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. Actually it's only been accepted by the Tenth Circuit as far as I know. You'd have a job convincing other courts to accept it. But it's there.

Carolina Vargas: Given these challenges, if any of these tax proposals in these three states are enacted, what would enforcement look like?

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

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

Roxanne Bland: Thank you. It's been a pleasure being here.

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