Maryland Sued over Digital Advertising “Tax”

Today, McDermott Will & Emery filed suit in Maryland federal court on behalf of a number of leading trade associations against Maryland Comptroller Peter Franchot, challenging the state’s recently enacted 10% gross receipts “tax” applicable to digital advertising revenue. The plaintiffs in the suit are the US Chamber of Commerce, the Internet Association, NetChoice and the Computer and Communications Industry Association. The suit asks that the court invalidate Maryland’s punitive imposition as violating several provisions of the US Constitution and the Internet Tax Freedom Act.

A file-stamped copy of the complaint is available below:

The complaint alleges that Maryland’s focus on internet advertising services (the tax does not apply to traditional advertising) discriminates against the internet, violating the Internet Tax Freedom Act. Next, because Maryland’s new law burdens and penalizes conduct occurring outside Maryland, it violates the Commerce and Due Process Clauses of the US Constitution. The complaint alleges that the characteristics of the imposition and the circumstances surrounding its enactment demonstrate a clear purpose and intent to punish out-of-state digital advertising companies for their extraterritorial activities.

The case is Civil No. 21-cv-410 (D. Md., filed February 18, 2021). Michael B. Kimberly, Paul W. Hughes, Stephen P. Kranz and Sarah P. Hogarth of McDermott, Will & Emery’s Washington, DC, office represent the plaintiffs.

Practice Note: The filing of this suit sends a signal to other states, like New York, Connecticut and Montana, where similar proposals are under consideration. Policymakers in those other states should recognize that following Maryland’s lead will only lead to the courthouse.



Maryland Enacts First Digital Advertising Services Gross Receipts Tax: Now What?

General Assembly Veto Override

On February 12, 2021, the Maryland General Assembly overrode Governor Larry Hogan’s veto of HB 732 (2020) (the Act), a bill enacting a first-of-its-kind digital advertising services tax on the annual gross receipts from the provision of digital advertising services in Maryland. The tax only applies to companies having annual gross revenues (without deduction of any expenses) from all sources of $100 million or more. The rate of the tax varies, depending on the level of global annual gross revenues, from 2.5% (for companies with $1 billion or less in global annual gross revenues) to 10% (for companies with more than $15 billion in global annual gross revenue). The rate applies to gross revenues from the performance of digital advertising services in Maryland. For instance, a company subject to the 10% rate having $100 million of revenue attributable to the performance of digital advertising services in Maryland would owe an annual tax of $10 million that will be reported and paid on a quarterly basis throughout the year.

Effective Date

Even though the legislation says the tax is effective July 1, 2020, under the Maryland Constitution, vetoed legislation becomes effective the later of the effective date in the bill or 30 days after the veto is overridden. Based on today’s veto override, the bill should become effective on or about March 14, 2021. However, because the legislation is “applicable to all taxable years beginning after December 31, 2020,” the digital advertising services tax will be retroactive to the beginning of this year.

Looming Compliance Deadlines

The digital advertising services tax applies on an annual basis with a return due on or before April 15 of the following year. However, the tax also requires quarterly filing and payment for certain taxpayers. On or before April 15 of the current year, persons subject to the tax are required to file a declaration of estimated tax showing how much Maryland digital advertising services tax they expect they will owe for the calendar year. As part of the declaration and quarterly with returns filed thereafter, the Act requires that they pay at least 25% of the estimated annual tax shown on the declaration. There is a penalty of up to 25% of the amount of any underestimate of the tax. The Act also creates a fine of up to $5,000 and criminal penalties of up to five years’ imprisonment for willfully failing to file the annual return.

Filing and Guidance TBD

At the time of writing, the Maryland Office of the Comptroller has not published any of the forms necessary for making the declaration of estimated tax or the return due on April 15 of the current year. The comptroller’s office also has not adopted regulations as required by the Act, providing guidance on when advertising revenue is derived in Maryland, likely a daunting and complicated task since this is a novel question that other states have not addressed. Many aspects of the Act are vague at best and likely need to be more robustly clarified through yet-to-be-issued administrative guidance. For example, the definition of “digital advertising services” (i.e., “advertising services on a digital interface”) includes a non-exhaustive list of examples including “other comparable advertising services.” As enacted, the scope of digital advertising services remains unclear. In the absence of guidance from the comptroller on the scope of these terms, persons subject to the tax will have a difficult time figuring which revenues are subject to the tax. If the comptroller does not publish the necessary forms or issue interpretative guidance before April 15 of this year, persons subject to the digital advertising services tax will have difficulty fulfilling their new compliance obligations.

Legal Challenge Anticipated

Based on its discrimination against electronic commerce and other constitutional concerns noted below, we expect a lawsuit will be filed in federal court seeking injunctive and declaratory relief on the basis that the Internet Tax Freedom Act (ITFA) preempts the tax and it violates the US Constitution. Specifically, the suit will claim the digital advertising services tax: (1) is preempted by ITFA because it imposes a “discriminatory tax on electronic commerce,” (2) violates the dormant Commerce Clause and Due Process Clause of the Fourteenth Amendment of the US Constitution by targeting and disproportionately favoring in-state interests at the expense of out-of-state interests, (3) violates the Foreign Commerce Clause of the US Constitution by preventing the federal government from speaking with one voice, (4) is void for vagueness under the Due Process Clause of the Fourteenth Amendment and invites arbitrary enforcement and (5) violates the First Amendment by burdening protected speech (advertising) in a manner not essential to the achievement of substantial government interest. As a result of these claims, the lawsuit will ask the federal court to declare the digital advertising services tax preempted and unconstitutional and permanently enjoin the comptroller from enforcing it.

Taxpayers with obligations for the new digital advertising services tax should explore options for protecting any rights to refunds of estimated tax payments should the legal challenge succeed. Companies seeking more information about the legal challenge and steps needed to preserve their refund rights under Maryland law are encouraged to contact the authors directly.

Tweaks on the Horizon

The sponsors of the digital advertising services tax recently introduced amendments (HB 1200 and SB 787) that would exclude radio and television broadcasters and news media entities from the scope of the tax. The amendment also would ban those subject to the tax from passing the tax on to customers through a separate fee, surcharge or line item on the invoice. These amendments are still early in the legislative process but are on a fast track and could become law prior to the initial return and payment due date in a few months. Stay tuned for more details as these companion bills advance.

Practice Note: The reporting and payment deadlines for the new digital advertising services tax enacted today loom, and there are many unanswered questions and finer details with regard to the scope and application of this first-of-its-kind state tax. With legal challenges anticipated and guidance on many key elements of the new tax needed for compliance lacking, we anticipate a challenging compliance process and a clear need for legal counsel to assist with navigating this new tax. Unfortunately, Maryland is not the only state to recently consider a digital advertising services tax. In fact, at least six additional states (Connecticut, Indiana, Montana, New York, Oregon and Washington) are actively considering the same or similar legislative proposals as part of their current legislative sessions. A successful lawsuit will chill efforts in those other states.

Companies who believe they may be subject to the Maryland digital advertising services tax should contact the authors immediately to discuss their potential compliance obligations created by the Maryland General Assembly’s February 12, 2021, action overriding Governor Hogan’s veto of the Act.



DC Council Expands False Claims Act to Tax Claims

The DC Council has passed an amended bill (the False Claims Amendment Act of 2020, B23-0035) that beginning as early as January 2021 will allow tax-related false claims to be raised against large taxpayers for up to 10 years of prior tax periods! This troubling legislation creates a real and imminent possibility of prior tax periods that are closed for assessment under the DC tax law pursuant to DC Code § 47-4301 being reopened by the DC attorney general and/or a private qui tam plaintiff.

While the introduced bill passed a first reading of the Committee of the Whole on Tuesday, November 17, 2020, by a vote of 8-5, the second reading (as amended) passed by a vote of 12-1 (a veto-proof supermajority) on December 1, 2020. The amended bill (as approved by the DC Council) will be sent to Mayor Muriel Bowser for consideration. If the mayor does not veto the bill or if her veto is overridden, the legislation will be assigned an Act number and sent to Congress for a 30-day review period before becoming effective as law. While extremely rare, Congress has an opportunity to reject the DC Council’s Act by passing a joint resolution, which must be signed by the president of the United States to prevent the Act from becoming law. Assuming this doesn’t happen, the Act will become law after the expiration of the 30-day Congressional review period. Assuming the Mayor quickly approves the legislation and Congress does not seek a joint resolution disapproving the Act, the legislation passed by the DC Council could take effect as early as next month!

As amended, the False Claims Amendment Act of 2020 passed by the DC Council will:

  • Remove the taxation bar that exists as part of current law (see DC Code § 2-381.02(d)) and replace it with explicit authorization allowing by the DC attorney general and private qui tam plaintiffs to pursue taxpayers for claims, records or statements made pursuant to Title 47 that refer or relate to taxation when “the District taxable income, District sales or District revenue of the person against who the action is being brought equals or exceeds $1 million for any taxable year subject to any action brought pursuant to this subsection, and the damages pleaded in the action total $350,000 or more.”
  • Require that the DC attorney general “consult with the District’s chief financial officer about the complaint” when tax-related claims are filed by a qui tam
  • Prohibits a claim by a qui tam plaintiff “based on allegations or transactions relating to taxation and that are the subject of an existing investigation, audit, examination, ruling, agreement or administrative or enforcement activity by the District’s chief financial officer.”
  • Not require the District’s chief financial officer “to produce tax information, or other information from which tax information can be inferred, if the production thereof would be a violation of federal law.”
  • Increase the maximum statutory reward for informants under the Taxation Title (DC Code § 47-4111) from 10% to 30% of the proceeds collected as a result of the information obtained.

Practice Note:

The passage of this False Claims Act expansion legislation by the DC Council is a very troubling development for taxpayers doing business in the District and threatens to subject them to the same nightmares (and the cottage industry of plaintiffs’ lawyers) that states like Illinois and New York have allowed over the past decade. As we have seen in those jurisdictions, opening the door to tax-related false claims can lead to significant headaches for taxpayers and usurp the authority of the state tax agency by involving profit-motivated private parties and the local attorney general (AG) in tax enforcement decisions.

Because the statute of limitations for false claims is up to 10 years after the date on which the violation occurs, the typical tax statute of limitations for assessment under the DC tax law will likely not protect taxpayers from false claims actions if this legislation takes effect in the coming months as anticipated. See D.C. Code § 2-381.05(a) (stating that an action may not be brought “more than 10 years after the date on which the violation . . . is committed”). As passed by the DC Council, there is no prospective application and upon becoming law the False Claims Act will immediately apply retroactively to reopen periods that are closed for assessment under the DC tax laws. If reopening prior tax periods up to seven years beyond what is permitted under current law was not enough, treble damages would also be permitted against taxpayers for violations, meaning District taxpayers would be liable for three times the amount of any damages sustained by the District. See D.C. Code § 2-381.02(a). When the starting point for negotiation is treble damages, one can imagine the companies regularly settle false claims attacks for sometimes large dollar amounts despite strong defenses to avoid the costs of litigation and potentially substantial financial risk that can quickly add up when tax, penalties and interest are multiplied. Sophisticated qui tam plaintiffs understand this and regularly extort money out of companies that are far from the “fraudsters” that false claims acts were originally aimed to punish. While the DC Tax law already provides the Office of Tax and Revenue (OTR) and the DC attorney general with more than enough tools to punish those committing fraud or tax evasion (including no statute of limitations, substantial penalties and interest, etc.), the DC Council apparently felt it was necessary to open the floodgates to private qui tam plaintiffs and allow them to take DC tax enforcement into their own hands.

A qui tam plaintiff who files a successful claim may receive between 15–25% of any recovery to the District if the District’s AG intervenes in the matter. If the qui tam plaintiff successfully prosecutes the case on their own, they may receive between 25–30% of the amount recovered. This financial incentive encourages profit-motivated bounty hunters to develop theories of liability not established or approved by the agency responsible for tax administration. While the legislation passed by the DC Council requires the DC attorney general to “consult with the District’s chief financial officer about the complaint” a similar provision under the New York False Claims Act has not given the Department of Taxation and Finance any meaningful autonomy and input in whether to pursue, permit or seek to dismiss the complaint. Allowing private parties to intervene in the administration, interpretation or enforcement of the tax law commandeers the authority of the tax agency, creates uncertainty and can result in inequitable tax treatment. In addition, while the protection against qui tam plaintiff claims for taxation matters “that are the subject of an existing investigation, audit, examination, ruling, agreement or administrative or enforcement activity by the District’s chief financial officer” is a step in the right direction, the protection does not go far enough. For example, it does not protect a taxpayer for matters (such as prior tax periods that are now closed) that were audited by OTR several years ago but are not the subject of an existing audit or examination. Thus, closed audit periods that were audited by OTR and for which OTR cannot assess a tax obligation pursuant to § 47-4301 may be reopened in the very near future and reexamined by the DC attorney general or qui tam plaintiffs as a result of the legislation passed. With such a lucrative and perverse incentive to raise fringe legal attacks in court against companies that have closed tax periods (and perhaps even destroyed related records pursuant to standard record retention laws and internal policies that would allow them to defend against the claims), we expect a cottage industry of plaintiffs’ lawyers to develop in the District of Columbia in 2021 similar what has transpired in Illinois and New York over the past decade. We can only hope that this legislation is an anomaly and doesn’t develop into a nationwide legislative trend in 2021.

We encourage all companies doing business in the District that are troubled by this legislative development to contact the authors to discuss what can be done to mitigate the substantial new risks that are expected to be enacted into law by the False Claims Amendment Act of 2020.



Governor Newsom Announces New Relief for Remitting California Sales Tax

On Monday, November 30, 2020, Governor Gavin Newsom announced that California will provide temporary tax relief for eligible businesses impacted by restrictions imposed to control the COVID-19 pandemic.

The announcement indicates that the Governor will direct the California Department of Tax and Fee Administration (CDTFA) to:

  1. Provide an automatic three-month extension for taxpayers filing less than $1 million in sales tax on the return and extend the availability of existing interest- and penalty-free payment agreements to companies with up to $5 million in taxable sales;
  2. Broaden opportunities for more businesses to enter into interest-free payment arrangements; and
  3. Expand interest-free payment options for larger businesses particularly affected by significant restrictions on operations based on COVID-19 transmissions.

No information was provided as to how the CDTFA will expand interest-free payment options for larger businesses, or what constitutes “significant restrictions” on a business’ operations for purposes of this temporary tax relief. Nevertheless, we applaud the governor’s move to initiate this relief for California’s taxpayers, and we will keep readers up to date as additional details are revealed for this program.



False Claims Act Tax Expansion Bill Advanced by DC Council

The DC Council has once again advanced a bill (the False Claims Amendment Act, B23-0035) that would allow tax-related false claims against large taxpayers! The bill passed a first reading of the Committee of the Whole on Tuesday, November 17, 2020, by a vote of 8-5. The bill is sponsored by Councilmember Mary Cheh, who introduced identical bills over the past few legislative sessions that ultimately were not passed. The troubling bill is now eligible for a second (and final) reading at the next legislative meeting on Tuesday, December 1, 2020.

As introduced, the bill would amend the existing false claims statute in the District of Columbia to expressly authorize tax-related false claims actions against a person that “reported net income, sales, or revenue totaling $1 million or more in the tax filing to which the claim pertained, and the damages pleaded in the action total $350,000 or more.” If enacted, it would make the District one of only a few jurisdictions that allow tax-related false claims actions across the country.

Practice Note:

The advancement of this legislation by the DC Council is a very troubling development for taxpayers doing business in the District and threatens to subject them to the same nightmares (and the cottage industry of plaintiffs’ lawyers) that states like Illinois and New York have allowed over the past decade. Because the current false claims statute includes an express tax bar, this bill would represent a major policy departure in the District. See D.C. Code § 2-381.02(d) (stating that “[t]his section shall not apply to claims, records, or statements made pursuant to those portions of Title 47 that refer or relate to taxation”). As we have seen in jurisdictions like New York and Illinois, opening the door to tax-related false claims can lead to significant headaches for taxpayers and usurp the authority of the state tax agency by involving profit-motivated private parties and the state attorney general (AG) in tax enforcement decisions.

Because the statute of limitations for false claims is 10 years after the date on which the violation occurs, the typical tax statute of limitations for audit and enforcement may not protect taxpayers from false claims actions. See D.C. Code § 2-381.05(a). Treble damages would also be permitted against taxpayers for violations, meaning District taxpayers would be liable for three times the amount of any damages sustained by the District. See D.C. Code § 2-381.02(a). A private party who files a successful claim may receive between 15–25% of any recovery to the District if the District’s AG intervenes in the matter. If the private party successfully prosecutes the case on their own, they may receive between 25–30% of the amount recovered. This financial incentive encourages profit-motivated bounty hunters to develop theories of liability not established or approved by the agency responsible for tax administration. Allowing private parties to intervene in the administration, interpretation or enforcement of the tax law commandeers the authority of the tax agency, creates uncertainty and can result in inequitable tax treatment.

While many other problems exist with application of false claims to tax matters, those issues are beyond the scope of this blog. Those concerned about this legislative development are encouraged to contact the authors.



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