Maryland breaks new ground in taxing digital realm

By Jennifer W. Jensen, CPA; Ferdinand Hogroian, J.D.; and Timothy G. Gorton, J.D.

On Feb. 12, 2021, Maryland's General Assembly enacted two bills over the veto of Gov. Larry Hogan that make major changes in the state's tax code. One is a sales tax on digital products and the other is a digital advertising tax.

The first bill, H.B. 932, expands the existing sales and use tax base to include "digital products," effective March 14, 2021. The second bill, H.B. 732, establishes a new digital advertising gross revenue tax — the first in any state. The effective date subsequently was delayed from 2021 until 2022. The digital advertising tax applies to annual gross revenue derived from digital advertising in Maryland and is imposed at scaled rates between 2.5% and 10%.

The two bills reflect separate and distinct trends in state taxation of the digital economy, and each raises significant compliance issues for businesses. While the sales tax on digital products reflects a continuing trend of state consumption tax base expansion in the digital arena, Maryland's interpretation of a "digital good" may be viewed as one of the most extensive iterations of such base expansion efforts in recent years. Additionally, the digital advertising tax is a new state gross revenue tax regime that seems to follow foreign digital service taxes (DSTs) enacted to address perceived shortcomings in international corporate income tax rules.

This column begins by discussing Maryland's sales tax on digital products and then focuses on the digital advertising tax.

Historical taxation of digital products

Traditionally, states imposed taxes on sales of tangible personal property and specifically enumerated services. In the past, most items that are now delivered digitally were transferred via tangible medium (e.g., compact disc). However, as more products and services began to be delivered digitally rather than in tangible format, some states looked for ways to tax these digital versions in order to protect their tax bases. For example, some states pursued taxation of digital products if they were the "digital equivalent" of tangible personal property.

Colorado is a recent example following a long line of states taking this approach. Colorado legislation enacted last year includes "digital goods" within the definition of "tangible personal property" and provides that "the method of delivery does not impact the taxability of a sale of tangible personal property." This includes compact disc, electronic download, and internet streaming. The legislation states it "codifies the Department of Revenue's long-standing treatment of digital goods, as reflected in its rule, and neither expands nor contracts the definition of 'tangible personal property.'"1 Unfortunately, prior to the Colorado legislation and a corresponding regulation2 that had been adopted earlier in the year, there was no clear guidance or support for taxpayers to rely on when making taxability decisions, other than experience or anecdotal reports that the department was taking a taxable position on audits.

Foreseeing the confusion that the taxation of digital goods could bring, the Streamlined Sales Tax (SST) project sought to bring simplification and harmonization to sales and use taxes, and to digital commerce specifically, when in 2007 it provided "specified digital products" definitions and rules for adoption by member states. For SST purposes, "specified digital products" means electronically transferred (other than via tangible storage media) "digital audio works," "digital audio-visual works," or "digital books." Computer software, which is classified as tangible personal property, and telecommunications, which is classified as a service, are excluded from the "specified digital products" definition. Twenty-four states have passed conforming legislation adopting these definitions when they choose to tax or exempt such products in their state's tax codes.

Observation: SST member states may tax digital products more broadly, but they must do so outside of the SST definitions. For example, Washington state imposes sales and use tax on these digital categories but also imposes sales tax on a category not defined by SST, "digital automated services." This is consistent with the SST framework, which binds states to following the SST definitions where applicable but allows states to tax (or exempt) other goods and services through separate, state-specific definitions.

Maryland's unique definition of digital goods raises questions

Rather than following the approaches of other states that tax digital goods, Maryland defined digital goods in its own manner. Rather than specifically identifying in its statutes what constitutes a digital product subject to sales and use tax (the SST approach), Maryland's statute broadly defined a "digital product" as a product that is obtained electronically by the buyer or delivered by means other than tangible storage media through the use of technology having electrical, digital, magnetic, wireless, optical, electromagnetic, or similar capabilities. The statute includes a list of certain digital products but does not limit taxation to those listed products.3

When the law was first enacted with an effective date in 30 days, taxpayers and practitioners assumed that Maryland would be taxing items in a manner similar to other states that had expanded taxation to digital goods. For example, most taxpayers and tax engine software providers assumed that cloud software and related services were not included.

However, three days before the effective date of the legislation, the Comptroller's Office issued Business Tax Tip #29,4 nonbinding guidance to taxpayers with an expansive list of items considered to be taxable digital products. These included cloud service offerings, online educational services (including those from accredited universities), satellite radio, and various advertising services. This expansive interpretation of digital goods or digital code turned Maryland from a state that did not tax digital products (and many services) into the most assertive state in taxing digital goods.

In response to the reaction from the business community, the Maryland General Assembly adopted further legislation to make two retroactive changes to the new digital tax that narrowed the comptroller's definition of digital goods.5 First, it enacted exclusions from the definition of a "digital product" for:

  • Prerecorded or live instruction by a public, private, or parochial elementary or secondary school or a public or private institution of higher education;
  • Live instruction in a skill or profession in a buyer's current or prospective business, occupation, or trade if the instruction features an interactive element between the buyer and the instructor or other buyers;
  • A live seminar, discussion, or similar event hosted by a not-for-profit organization or business association that features an interactive element between the buyer and host or other buyers; and
  • A professional service obtained electronically or delivered through the use of technology having electrical, digital, magnetic, wireless, optical, electromagnetic, or similar capabilities.

Second, it amended the exclusion under existing law (not part of the digital products legislation enacted earlier in the year) for "custom computer software services." The amendments specify that this exclusion applies:

  • To "custom computer software, regardless of the method transferred or accessed, or a service relating to custom computer software."
  • If the custom computer software is created for use by a specific person or contains standard or proprietary routines "requiring" significant creative input to customize, "configure, or modify" the procedures and programs "that are necessary to perform the functions required for the software to operate as intended."

In response, the Maryland Comptroller's Office revised Tax Tip #29 to incorporate the legislative changes.6 The revised guidance deleted the "non-exclusive list of [taxable] digital products" from the earlier guidance and stated that otherwise nontaxable services do not become taxable services merely because they involve delivery of a digital product. For example, the revised guidance recognizes that a contract with an advertising agency may involve components of both nontaxable services and the production of a product that is either tangible personal property or a digital product. The revised guidance also provides that a monthly charge for either satellite radio or satellite television service is not subject to the sales and use tax.

Observation: At the same time, certain categories from the original guidance remain and elaborate on the statutory language. For example, the guidance provides that a digital product includes "a chat room, discussion, weblog, or any other venue that permits users to communicate electronically in real time." Therefore, from the beginning, the guidance appears to take the position that a digital product includes electronic communications. Most states have not directly addressed these types of products and services other than seeking to tax them as software and not as digital goods; including them in its definition of digital goods is unique to Maryland.

Custom computer software

Regarding custom computer software, the revised guidance provides that customized, configured, or modified software "is software that does not operate immediately as required by the buyer (i.e., 'out of the box') and includes enterprise software." Software as a service (SaaS) is taxable under the comptroller's interpretation unless the exclusion for customized software applies. Because the taxation of electronically delivered software and SaaS was not clearly identified in the enacting legislation, extension of the sales tax to these items caught many businesses by surprise and makes the interpretation and application of the "customized software" exclusion critical.

The revised guidance includes a long list of business software uses that might qualify for the customized software exclusion and 11 examples. The examples provide clear-cut statements of nontaxability, such as where the software requires "substantial configuration" to operate as intended. The same software functionality is deemed taxable where it involves "a simpler software plan geared to individuals or a limited number of users in Maryland that does not require configuration to use."

Observation: While the examples reflect the "custom software" amendments in the legislation, they merely offer conclusory statements that either "substantial" configuration is required or no configuration is required. These simplified scenarios may not provide adequate guidance for taxpayers seeking to apply the general concepts of software taxability to their specific facts.

The legislation's effective date

Another area of uncertainty initially was that the legislation and the original Tax Tip #29 were silent regarding software and digital goods that are accessed or used in multiple locations. Upon request by the business community, the guidance was revised. The revised guidance provides that if the vendor receives a written statement from the buyer at the time of sale, the vendor "may charge Maryland sales and use tax based on the percentage of use in Maryland."

However, the guidance does not allow purchasers to remit use tax based on their in-state use (such as by issuing a multiple-points-of-use exemption certificate) but instead requires sellers to collect tax based on written representations from the purchaser (or, without such representations, under the general sourcing hierarchy). The revised guidance also provides that a buyer may file a refund claim if a vendor is unable to charge Maryland sales and use tax based on a percentage of total sales and clearly states that a vendor's obligation to charge and collect tax is not waived under these circumstances.

Looking ahead on digital product sales and use taxes

Digital product sales tax imposition and base expansion continue to be considered in multiple states. For example, legislation proposed in Georgia in the 2021 regular session would expand the sales tax base broadly to "sales of digital goods or services" and include "prewritten computer software" within the definition.7 Likewise, proposed Nevada legislation would impose a new excise tax parallel to the sales and use tax on digital products, defined to include prewritten computer software.8 Both proposals, and others, are likely to be reintroduced in 2022.

Taxing digital services at the US state level

Turning now to the subject of digital advertising, on the same day that it approved expansion of its existing sales and use tax to digital products, Maryland also adopted a first-in-the-nation digital services tax (DST) on digital advertising gross revenue. Unlike sales tax base expansion to digital goods and services, which has been a continuing area of consideration in states for many years, the digital advertising tax may have been intended to follow recent actions by certain foreign countries to adopt a DST.

The foreign consideration of DSTs was a response to perceived shortcomings in the taxation of multinational corporate income. Several adopting nations have since committed to repealing their DSTs once "Pillar One" of the OECD/G20 Inclusive Framework proposal is implemented.9

Observation: States approach corporate income taxation from a different perspective than most nations. States tax all the apportioned income of U.S. corporations (with some exceptions, e.g., 80/20 companies), increasingly by using single sales factor apportionment and market-based sourcing. International corporate taxation generally is premised on either a "territorial" basis or a "worldwide" basis with foreign tax credits allowed. States, however, seem to be responding to an argument that the digital economy has not been paying its "fair share" of tax revenue.

While Maryland was the first state to adopt a digital advertising gross revenue tax, it was not alone in considering the measures. Bills have been introduced in more than a dozen states in the past two years to impose a similar digital advertising gross revenue tax, a social media advertising tax, a sales tax on digital advertising services, a "data tax," or some other DST variation.

Apart from Maryland's enactment, Connecticut probably came closest to enacting a DST in 2021. The Joint Finance, Revenue and Bonding Committee approved a budget implementation bill that included a digital advertising gross revenue tax.10 However, the final budget sent to and approved by Gov. Ned Lamont did not include these provisions. Still, there was favorable discussion of the policy in committee hearings, and neighboring Massachusetts has multiple bills pending to impose similar provisions.

Maryland enacts a first-in-the-nation DST

Under Maryland's legislation, digital advertising services include advertising on a digital interface (any type of software, including a website, part of a website, or application that a user is able to access). Examples in the legislation include banner advertising, search engine advertising, interstitial advertising, and other comparable advertising services. A person must have annual gross revenue derived from digital advertising services in Maryland of at least $1 million to be subject to the tax in any year.11

The base rate of tax is 2.5% for a person with global annual gross revenue (from any source, not just digital advertising) of $100 million through $1 billion. The rate rises to 5% for a person with annual global gross revenue up to $5 billion; 7.5% up to $15 billion; and 10% over $15 billion. Annual gross revenue "means income or revenue from all sources, before any expenses or taxes, computed according to generally accepted accounting principles."

A person exceeding any of these thresholds is subject to tax at the designated rate for the entire taxable base (digital advertising service annual gross revenue apportioned to Maryland). Apportionment under the legislation requires applying a fraction to annual gross revenue from digital advertising services, the numerator of which is the annual gross revenue of a person derived from digital advertising services in Maryland, and the denominator of which is the annual gross revenue of a person derived from digital advertising services in the United States.

In May 2021, Maryland enacted legislation to delay the effective date of the digital advertising tax.12 The first measurement period for the tax was moved from 2021 to 2022, meaning that the tax first will be measured by gross revenue from digital advertising services recognized in the 2022 calendar year. Further, the first estimated payment will be due April 15, 2022.

The legislation also made two substantive changes to the digital advertising tax. First, it provides that the tax may not be directly passed to customers "by means of a separate fee, surcharge, or line-item." Second, it provides that digital advertising services do not include advertising "on digital interfaces owned or operated by or operated on behalf of a broadcast entity or news media entity."

Regulations highlight compliance issues

On Dec. 8, 2021, the Comptroller's Office published final regulations on apportioning the digital advertising tax.13 A comparison with the Maryland statute is interesting.

The statute provides that the numerator of the apportionment fraction "is the annual gross revenues of a person derived from digital advertising services in the state" and the denominator "is the annual gross revenues of a person derived from digital advertising services in the United States."

However, the regulations do not use a gross revenue apportionment fraction but instead provide: "An apportionment factor shall be developed as a fraction where the numerator is the number of devices that have accessed the digital advertising services from a location in the State, and the denominator is the number of devices that have accessed the digital advertising services from any location."

Observation: This statement appears to conflict with the statute in that the denominator could be worldwide, as opposed to solely the United States. However, the regulations also provide: "Revenues from digital advertising services are derived in the United States when any portion of those services are accessed by devices within the United States." It is unclear why this would need to be known unless it is for apportionment purposes.

'Device' and 'location'

Under the regulations, a "device" is "any medium through which digital advertising services may be accessed, including stationary or portable computing devices, tablets, phones, and smart devices." "Location" is "the actual, physical location of a digital interface when a digital advertising service is accessed by a user."

The location of a device is determined by using the totality of the data within the taxpayer's possession or control that most reliably identifies a device's location, including both technical information and nontechnical information included in the contractfor digital advertising services. This technical information includes internet protocol, geolocation data, device registration, cookies, or "industry standard metrics." The regulations also reference the "totality of the facts and circumstances" in determining device location.

Observation: While information regarding device location may be available, tax departments' access to such information and whether the information will be deemed sufficient by the Comptroller's Office remain major areas of uncertainty.

Throwout rule

The regulations also include a "throwout" rule: "Devices whose location are indeterminate shall be excluded from both the numerator and denominator of the apportionment factor."

Observation: In addition to the possible distortive effect of this rule, there is no certainty that the Comptroller's Office will agree that a device location could not be assigned.

Observation: The regulations do not provide a safe harbor, alternative methods, or means to ensure that the sole method provided (device location with a throwout rule) does not result in a distorted attribution of gross revenue to Maryland. The regulations do not address fundamental issues with the statute's vagueness, including what constitutes "digital advertising" services and who is subject to the tax.

Where to next?

Litigation is pending in federal and state courts seeking to bar implementation of the Maryland digital advertising gross revenue tax, but a final decision appears unlikely in time for the compliance deadlines beginning with the first estimated tax payment due April 15, 2022. While both suits raise constitutional issues, a core issue in the taxation of "digital advertising" is whether targeting such activity discriminates against electronic commerce in violation of the federal Internet Tax Freedom Act, P.L. 105-277.

As the litigation continues, academics, policymakers, and multistate organizations are taking notice of the new trends in state taxes and are analyzing potential paths forward. The Multistate Tax Commission (MTC) has established a work group "to advise on the drafting of a white paper" to address state taxation of digital products.14 It appears the group's efforts will focus on sales and use taxes and an "analysis of the ways that digital products might be defined, categorized, exempted and sourced."

However, states are not bound by the MTC's recommendations, and, in any event, drafting legislative language may not be imminent. In the meantime, states are expected to continue to consider and adopt legislation expanding their sales and use taxation of digital products.

It remains to be seen whether litigation and international tax developments will affect state consideration of DSTs. With 2021 as a guide, it appears likely this trend will continue as well, at least for legislative proposals.


1Colorado H.B. 1312, §1(c)(II), enacted June 23, 2021. See PwC's Insight, "Colorado Enacts Digital Tax, 'Tax Haven,' and Passthrough Entity Tax Measures" (July 1, 2021), for details.

2Colorado Rule 39-26-102(15), 1 Colo. Code Regs. §201-4, published Jan. 10, 2021. See PwC's Insight, "Colorado Rule Applies Sales Tax to Digital Media, Streaming Services" (January 2021), for details.

3Maryland H.B. 932, enacted Feb. 12, 2021. See PwC's Insight, "Maryland Expands Sales Tax Base to Include Digital Products and Codes" (March 1, 2021), for details.

4Maryland Comptroller's Office, Business Tax Tip #29, "Sales of Digital Products and Digital Codes" (March 11, 2021). See PwC's Insight, "Maryland Interprets New Tax on Digital Products; Provides Filing, Payment Extension" (March 16, 2021), for details.

5Maryland S.B. 787, enacted May 12, 2021. See PwC's Insight, "Maryland Legislature Approves Digital Ad Tax Delay, Digital Products Amendments" (April 13, 2021), for details.

6Maryland Comptroller's Office, Business Tax Tip #29, "Sales of Digital Products and Digital Codes" (updated June 3 and July 14, 2021). See PwC's Insight, "Maryland Updates Digital Products Sales Tax Guidance" (July 30, 2021), for details.

7Georgia H.B. 594, introduced Feb. 24, 2021.

8Nevada S.B. 346, introduced March 24, 2021. The bill received a third reading in the Senate, but it was re-referred to committee due to its anticipated failure to reach the state's supermajority vote requirement.

9See Joint Statement from the United States, Austria, France, Italy, Spain, and the United Kingdom, Regarding a Compromise on a Transitional Approach to Existing Unilateral Measures During the Interim Period Before Pillar 1 Is in Effect (Oct. 21, 2021). The statement explains, "From the outset, a key impetus of the OECD/G20 Inclusive Framework's negotiations was to stop the proliferation of 'Digital Services Taxes and other relevant similar measures' ... by replacing them with a consensus-based reallocation of taxing rights among Inclusive Framework (IF) members."

10Connecticut H.B. 6443, reported out of Legislative Commissioners' Office, May 10, 2021.

11Maryland H.B. 732, enacted Feb. 12, 2021. See PwC's Insight, "Maryland Enacts First-in-the-Nation Digital Advertising Tax" (Feb. 16, 2021), for details.

12Maryland S.B. 787, enacted May 12, 2021. See PwC's Insight, "Maryland Legislature Approves Digital Ad Tax Delay, Digital Products Amendments" (April 13, 2021), for details.

1348-25 Maryland Register 1079 (Dec. 3, 2021).

14See MTC, Sales Tax on Digital Products, for more information.



Bridget McCann, CPA, is managing director of State and Local Tax at Grant Thornton LLP in the Philadelphia area. Jennifer W. Jensen, CPA, is a partner with PwC in Washington, D.C. Timothy G. Gorton, J.D., is a director with PwC in Philadelphia. Ferdinand Hogroian, J.D., is a director with PwC in Albany, N.Y. Ms. McCann is the chair, Ms. Jensen is a past chair, and Mr. Gorton and Mr. Hogroian are members of the AICPA State & Local Tax Technical Resource Panel. For more information about this column, contact


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