When Worlds Collide: How Tangible Tax Burdens Attach to Digital Commerce in the United States (Part 2) | Miller Nash LLP

introduction

Part 1 of this series discussed the proposals adopted by different countries to tax the digital economy, in particular through taxation of various types of digital advertising and other digital services. These taxes allow countries to reach out to taxpayers who are not resident in their jurisdiction and to generate income from the activities these taxpayers undertake to gain access to the market in the area administered by the tax authority.

The Potential of Increasing Revenue from New Sources Is Not Lost in the Different States in the US Until relatively recently, states have been passively watching companies exploit the goldmine of user-generated data created by their residents and not be able to tax these companies because of it no physical connection to the state. Over time, some of the more aggressive states are pushing sales tax policies that impose tax collection obligations on foreign companies. Taxes on digital services levied by different countries around the world now represent a new approach for states to generate income outside their borders. The states see these taxes, among other things, as an opportunity to get successful companies to pay their “fair share”, to provide consumer protection and additional levels of regulation for the use and exploitation of personal data, and to hold technology companies responsible for the high costs for the various social and cultural sectors political ills caused by social media, misinformation, content censorship, etc.

An unfortunate downside to these taxes are patchwork requirements and thresholds; There is no single digital service tax roadmap that states can follow. For example, these taxes are often collected for completely different activities: providing online services, selling personal information, providing access to social media, or selling digital advertising. For the purposes of this article, all of these taxes will be referred to interchangeably as digital services taxes, unless expressly stated otherwise. The variety of approaches to digital taxation can be a trap for careless taxpayers who unwittingly fall into a state’s tax authority.

background

Early this year, Maryland became the first US state to impose a tax on digital services and advertising. Since then, several other states, including Massachusetts, New York, Texas, and West Virginia, have passed similar laws. Meanwhile, other states such as Oregon, Washington, and Montana have passed similar laws, but have decided to abandon these efforts for the time being.

In contrast to digital taxes, which are levied under the national laws of foreign states, digital taxes in the US face a number of steep hurdles under the US Constitution (including challenges under the Supremacy Clause, Commerce Clause and Due Process Clause), Federal laws (including the Permanent Internet Tax Exemption Act) and various provisions of the applicable state constitutions. Currently, several lawsuits are seeking Maryland digital service tax for similar constitutional and other legal reasons.

In the future, additional challenges for the taxation of digital services at the federal level could arise, since the adoption of a global minimum tax (Pillar 2 of the OECD framework for basic erosion and profit shifting, discussed in part 1 of this series) means the abolition of digital service taxes of all kinds, with the exact point in time and the extent of such an abolition remains to be seen.

Maryland Digital Advertising Tax

Maryland’s Digital Advertising Tax was enacted in early 2021 and certain requirements were clarified through subsequent amendments and proposed ordinances issued in August 2021. As with the various proposals in other countries, Maryland’s digital tax is levied on gross revenues from digital advertising services in the state (more precisely, “advertising services on a digital interface”). This tax only applies to businesses with $ 1 million or more in Maryland digital advertising revenue. When the tax is incurred, the tax rate escalates based on the company’s annual global sales.

Maryland-specific revenue (i.e., revenue subject to that tax) is determined by multiplying the taxpayer’s total revenue by the ratio of the number of devices accessing the taxpayer’s digital advertising services from Maryland to the number of devices being used from any given location from accessing these services.

To determine what Maryland revenue is and will be taxed, the taxpayer must first understand how many devices are accessing their digital services and then determine where the users of those devices are located. Maryland’s tax structure relies on the location of the device to determine where users are and, in turn, requires taxpayers to use whatever information they know, including technical information, digital advertising contracts, internet log, geolocation data, device registration, cookies, and others comparable information to identify the location of any device accessing its digital services. If the location of a device is uncertain due to the use of a VPN, IP proxy, or roaming cell coverage (among myriad other causes of uncertainty), the revenue generated from such a device is not included in the calculation.

Oregon digital tax

In 2021, Oregon House Bill 2392 was introduced to impose a 5 percent tax on gross proceeds from the sale of personal information to Oregonians. The Bill, in its written form, applies to the sale of information gathered or aggregated from online sources that may identify, relate to, describe, or be associated with an Oregon resident. As with the Maryland proposal, location would largely be determined by reference to the IP address.

Although Oregon’s digital tax law was ultimately abandoned, it’s illuminating for a number of reasons. This bill provides insight into the current mindset of the Oregon Legislature and its intent to protect consumers while taxing the activities that make a profit within their boundaries. There are realistic hurdles a digital tax bill would have to overcome before it could become law in Oregon, not least Oregon corporate tax, which is already on income from digital activities (including sales of personal information, advertising, and the like). However, this could be a tax to look out for in the future, especially if the Maryland tax survives its own constitutional and legal challenges and provides a blueprint for other states.

Other western states

Both Washington and Montana will introduce taxes on digital businesses in 2021. The Montana proposal would have levied a 10 percent tax on digital advertising service revenue generated by companies with more than $ 25 million in annual revenue, while the Washington approach was more similar to Oregon’s proposal. Like the proposed Oregon tax, the Washington law would have been imposed on the sale of personal information; however, the tax would have been levied as an addition to the ordinary trade and business tax of the state. And, like the Oregon proposal, taxes found no support in either Washington or Montana and were eventually left for later scrutiny.

Bring away

Even if state-imposed digital service taxes are still in their infancy, many states are jumping on the bandwagon. Without a model or guidance to follow, a nationwide patchwork of digital service taxes will add complexity and create the potential for double taxation of revenues from digital activities. One specific cause of confusion is that countries appear to have different approaches to the digital economy and therefore focus on different activities that should be taxed: digital advertising, using social media, or selling personal data. While some states or regions impose a tax on all of these activities, other states have draft laws that highlight one. For example, states on the Pacific coast appear to be particularly biased towards taxing the sale or use of personal information, while nearby western states appear to be more biased towards Maryland’s advertising tax.

Businesses should watch the evolution of various taxes on digital services across the country, especially in states where they earn income from selling advertising, customer information, or accessing social media online. It is no longer okay to assume that physical presence in a state is a requirement for taxation or that doing business in a digital medium is under the radar. States are driving innovative tax policies in an attempt to address the economies of the present and future of the digital economy.

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