Maryland: Digital ad and pass-through entity tax bills pending action by governor

In the last hours before the Maryland General Assembly adjourned early due to the Coronavirus, several tax bills were passed by the House and Senate. The bills are intended to help fund an expansive education reform plan, which also passed during the shortened regular session. It has been reported that Governor Hogan is likely to veto at least some of these bills, which would necessitate legislators to return to Annapolis for a veto override vote. One of the currently-enrolled proposals, House Bill 732, was amended to include provisions (previously included in standalone bills) imposing a tax on digital advertising gross revenues. Specifically, effective for tax years beginning on or after December 31, 2020, a new tax would be imposed on annual gross revenues derived from digital advertising services in Maryland.  Digital advertising services is defined as “advertisement services on a digital interface,” with any type of software, website, or application being considered a digital interface. Digital advertising revenues would be sourced to Maryland using an apportionment factor that is based on annual gross revenues derived from digital advertising in Maryland over the taxpayer’s annual gross revenues derived from digital advertising in the United States. The bill directs the Comptroller to adopt regulations to determine the amount of revenue derived from each state in which digital advertising services are provided. The tax would apply to companies that have (a) global annual gross revenues of $100 million or more and (b) digital advertising revenues sourced to Maryland of $1 million or more. Using a four-tiered rate regime based on global revenue, the tax rate would range from 2.5 percent up to 10 percent for taxpayers with greater than $15 billion in global annual revenue. Every company expecting to be subject to the tax would be required to make quarterly estimated tax payments. House Bill 732 also makes various changes to state law to address administration of the new tax.

Another enrolled bill is House Bill 932, the 21^st Century Economy Sales Tax Act. As passed both chambers, this bill redefines the term “retail sale” to include the sale of certain digital products effective July 1, 2020. A “digital product” is defined 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 specific digital products subject to tax generally follow definitions for audio and audio-visual products as well as e-books used in a number of states; the Maryland bill also specifically includes ring tones, e-greeting cards and digital newspapers, magazines and other media. Sales tax would also apply to sales of subscriptions to, access to, streaming of or the purchase of a digital code for receiving or accessing digital products to an end user. For sourcing purposes, the retail sale of a digital code or digital product would be presumed to be sourced to the state in which the customer’s tax address is located. A specific hierarchy applies to determine a customer’s tax address.  As amended, the sales and use tax collected on the sale or use of digital products may be distributed to help fund costs associated with the Coronavirus or the state revenue stabilization fund.

Finally, on the income tax side, Senate Bill 523 was amended to include a new election for pass-through entities to pay tax at the entity level with respect to resident owners.   Under current law, tax is imposed on each pass-through entity that has a nonresident member and nonresident taxable income for the tax year. The tax is treated as a tax imposed on the nonresident member that is paid on behalf of the nonresident by the pass-through entity and operates essentially as a withholding tax. Effective for tax years beginning after December 31, 2019, Senate Bill 523 would allow pass-through entities to elect to pay tax at the entity level with respect to the distributive shares or pro-rata shares of resident members of the pass-through entity. For pass-through entities that make the election, the tax imposed would be the sum of (i) the rate equal to the sum of the county income rate and the top marginal state tax rate for individuals applied to the sum of each individual member’s distributive share or pro rata share of the pass–through entity’s taxable income; and (ii) the rate of the tax for a corporation applied to the sum of each entity member’s distributive share or pro rata share of the pass–through entity’s taxable income. The tax cannot exceed the sum of all the members’ shares of the pass-through entity’s distributive cash flow. Each member would be able to claim a credit against the tax imposed by Maryland on the member for the member’s proportionate share of the tax paid by the pass-through entity.  Senate Bill 523 would also revise the provisions of Maryland law that allow residents a credit for taxes paid to other states in light of the new pass-through entity election. If signed, Senate Bill 523 would also amend provisions related to Worldwide Headquartered Companies. Under current law, “Worldwide Headquartered Companies,” as defined, can elect each year to calculate their Maryland apportionment using a three factor double-weighted sales formula.  These are generally corporations that (1) filed a Form 10-Q with the SEC for the quarterly period ending June 30, 2017, (2) have their principal executive office in Maryland, and (3) between July 1, 2017 and June 30, 2020 employed at least 500 full-time employees at the Parent Corporation’s principal executive office in Maryland. Senate Bill 523 would amend the definition of a “Worldwide Headquartered Company” to include parent corporations that are franchisors and that, during the relevant time period, employ at least 400 full-time employees in Maryland at the corporation’s principal office. Please stay tuned to TWIST for updates on these bills and information on when Maryland lawmakers will reconvene in Annapolis.

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