TWIST - This Week in State Tax

Welcome to TWIST for the week of April 11th, featuring Sarah McGahan from the Washington National Tax State and Local Tax practice.

First up today, the Maryland Gross Revenues Digital Advertising Tax is imposed on entities with global annual gross revenues of at least $100 million that have annual gross revenues derived from digital advertising services in Maryland of at least $1 million. Every person that reasonably expects their Maryland gross revenues attributable to digital advertising services to exceed $1,000,000 must make quarterly estimated tax payments. The Comptroller’s office recently released Form 600D that is used to calculate the estimated digital advertising tax for the 2022 tax year and each quarter.  This year, due to the Good Friday holiday, the first estimated payment is due on April 18, 2022.

In other Maryland news, the Court of Special Appeals recently held that a Tribal Corporation taxpayer that was not subject to federal income tax did not have federal taxable income and was therefore not subject to Maryland corporate income tax. The court concluded that the Comptroller does not have authority to levy taxes on income that is not included in a taxpayer’s federal taxable income.

In Oklahoma, the state supreme court addressed an issue of great importance to taxpayers—when corporate income taxes are deemed paid for purposes of filing a timely claim for refund. Although the statute was ambiguous, after examining all the relevant statutes and the federal rules, the court held that the taxpayer’s taxes were deemed paid when it filed its return on the extended due date.

Finally, the Washington State Court of Appeals affirmed the City of Tacoma’s interpretation of the B&O Tax service income apportionment provisions in effect for the tax years at issue. The taxpayer argued that the statute’s apportionment options had to be applied as a cascading hierarchy. The court disagreed. In its view, the statute set forth three alternative methods of apportioning a taxpayer’s service income, allowing the tax authority to select the method that most fairly and accurately apportioned service receipts. 

Thank you for listening to TWIST and stay well!

Maryland: Comptroller Issues Digital Advertising Tax Estimated Payment Form

Download PDF

Effective January 1, 2022, every person that reasonably expects their Maryland gross revenues attributable to digital advertising services to exceed $1,000,000 for the calendar year must make quarterly estimated digital advertising gross revenues tax payments. The Comptroller’s office recently released Form 600D that is used to calculate the estimated digital advertising tax for the 2022 tax year and each quarter.  If the amount of estimated tax due for a quarter exceeds $10,000, payment by ACH is required. Per the statute and the form, the first quarterly digital advertising tax estimated payment is due on Friday April 15, 2022. This year, April 15 happens to be Good Friday, which is a legal holiday in Maryland.  There is a law in Maryland stating that payments due on a legal holiday are pushed to the next weekday. As such, the payment due date is extended to April 18, 2022. 

Overview of the Tax

The Maryland Gross Revenues Digital Advertising Tax became effective for tax years beginning after December 31, 2021. The tax is imposed on entities with global annual gross revenues of at least $100 million that have annual gross revenues derived from digital advertising services in Maryland of at least $1 million in a calendar year.[1] The tax is imposed on a separate entity

basis.  The assessable tax base is a person’s annual gross revenues derived from digital advertising services in Maryland. No deductions of any kind are allowed. The definition of a “digital advertising service” includes “advertisement services on a digital interface, including advertisements in the form of banner advertising, search engine advertising, interstitial advertising, and other comparable advertising services.” The term does not include advertisement services on digital interfaces owned or operated by or on behalf of a broadcast entity or news media entity, as defined.  A “digital interface” is “any type of software, including a website, part of a website, or application, that a user is able to access.”

The tax rate is tiered:

1. 2.5% of the assessable base for a person with global annual gross revenues of $100,000,000 through $1,000,000,000
2. 5% of the assessable base for a person with global annual gross revenues of $1,000,000,001 through $5,000,000,000
3. 7.5% of the assessable base for a person with global annual gross revenues of $5,000,000,001 through $15,000,000,000
4. 10% of the assessable base for a person with global annual gross revenues exceeding $15,000,000,000.

The tax is based on a calendar year and the annual return is due April 15 of the following year. If a person “reasonably expects” their annual gross revenues derived from digital advertising services in Maryland to exceed $1 million, they must file a declaration of estimated tax along with a quarterly payment by April 15 of the current year (April 18 for 2022), and then a quarterly payment by June 15, September 15, and December 15 of the current year. The underpayment penalties for corporate income tax also apply to this tax. That is, a 25% penalty is imposed when the estimated tax payments are (1) less than 90% of the current year tax and (2) less than 110% of the prior year tax. The instructions for Form 600D also provide that at least 25 percent of the estimated tax due is to be paid with each installment.

Determining the tax attributable to Maryland

Under Md. Code Ann. Tax-Gen. § 7.5-102, the tax is imposed on annual gross revenues derived from digital advertising services in Maryland. The statute directed the Comptroller to adopt a regulation that determined the state from which revenues from digital advertising services are derived. Md. Code Regs. 03.12.01.02 adopts an apportionment formula that is based on the number of devices accessing a person’s digital advertising services. The numerator of the apportionment factor is the number of devices that have accessed the digital advertising services from a location in Maryland. The denominator is the number of devices that have accessed the digital advertising services from any location. Examples make clear this includes locations outside the U.S. The developed apportionment factor is applied to the overall digital advertising gross revenue received by the taxpayer to compute the digital advertising gross revenue attributable to Maryland.

What if the location of a user’s device is not known to the taxpayer?  Devices whose locations are indeterminate are excluded from both the numerator and denominator of the apportionment factor, without any adjustment to the amount of revenue to be apportioned.  The location of a device is to be determined by the taxpayer using the totality of the data within their possession or control, including both technical information and nontechnical information included in the contract for digital advertising services.

Legal Challenges to the Maryland Digital Advertising Tax

Lawsuits challenging Maryland’s digital advertising tax on Due Process and Commerce Clause grounds and on the basis that the tax violates the Internet Tax Freedom Act were filed in state and federal court.  In early March, a federal district court ruled that under the Tax Injunction Act, it lacked jurisdiction over the suit challenging the tax. The federal district court did rule, however, that it could address one aspect of the lawsuit challenging a provision in the Maryland law that prohibits companies from directly passing the digital advertising tax on to customers.

In the interim, the lawsuit filed in state circuit court is moving forward. The plaintiffs allege that the tax is unconstitutional under the Commerce Clause and Due Process Clause; the tax violates the Internet Tax Freedom Act; and the legislature improperly delegated its authority to the Comptroller regarding the calculation of the tax. On a motion to dismiss filed by the state, the circuit court judge held that the lawsuit may proceed on the constitutional and Internet Tax Freedom Act arguments but dismissed the plaintiffs’ argument of improper delegation of authority.

The due date for the first estimated payment is quickly approaching and there are still many uncertainties around the scope of the tax, as well as whether the tax is permissible under federal law.  Please contact Jeremy Jester, Sarah McGahan, or Jeff Cook with questions on computing the first estimated payment, or the tax in general. 

[1] Md. Code Regs. 03.12.01.05(A)(1) provides that the declaration must be filed even if the person owes no digital advertising tax.  However, only a person who reasonably expects their gross revenues attributable to digital advertising services in Maryland to exceed $1 million for the calendar year must make quarterly estimated payments and file the declaration. As such, the regulation appears to require a declaration from persons that have $1 million of gross revenues from digital advertising services attributable to Maryland, but that do not meet the overall $100 million annual gross revenues threshold to be subject to the tax.

Maryland: Pass-through Entities Owned by Chartered Tribal Corporation Not Subject to Tax

Download PDF

The Maryland Court of Special Appeals recently addressed whether a taxpayer that was not subject to federal income tax had federal taxable income for Maryland purposes. The case involved a federally chartered section 17 tribal corporation that owned a tribal government LLC. The tribal government LLC wholly owned six subsidiary LLCs. The subsidiary LLCs derived all or substantially all their income from service contracts with the federal government. None of the subsidiaries made a check-the-box election to be treated as corporations for federal income tax purposes. The subsidiary LLCs mistakenly filed Maryland corporate income tax returns for 2012. Thereafter, the Comptroller assessed each subsidiary for Maryland income tax. The assessments were affirmed by the lower courts on the basis that the subsidiaries were separate from the tribal corporation and did not benefit from its federal tax immunity.

Before the Court of Special Appeals, the subsidiary LLCs argued that an entity is subject to Maryland income tax if, and only if, it has federal taxable income. Therefore, because the tribal corporation was not subject to federal income tax, the subsidiaries asserted it was not taxable under Maryland law, which in turn meant that the subsidiary LLCs were not taxable. The Comptroller, on the other hand, argued that the subsidiary LLCs derived income from doing business in Maryland and, as other pass-through entities with nonresident owners, must file an annual return and remit tax on behalf of their nonresident owners. The Comptroller also asserted that the subsidiaries had federal adjusted gross income despite having no obligation to file a federal income tax return. 

The court first determined that that because the owner of the subsidiary LLCs was itself a SMLCC, the tax that would be paid by the LLCs was actually imposed on the tribal corporation’s income. The court’s next task was to determine whether the tribal corporation had income that was taxable under Maryland law.  After holding that the Comptroller does not have authority to levy taxes on income that is not included in a taxpayer’s federal taxable income, the final question before the court was whether the tribal corporation’s income was taxable under federal law. The court concluded that Native American tribes are not subject to federal income tax and a section 17 tribal corporation “shares in that status.” As such, because the tribal corporation had zero federal adjusted gross income, the subsidiaries had zero nonresident taxable income and no tax was owed. Please contact Dan McGuire with questions on A+ Government Solutions, LLC, et al. v. Comptroller of Maryland.

Oklahoma: Court Addresses When Taxes are Paid for Statute of Limitations Purposes

Download PDF

Recently, Oklahoma’s highest court addressed an issue of great importance to taxpayers—when corporate income taxes are deemed paid for purposes of filing a timely claim for refund. The corporate taxpayer’s return was originally due on March 15, 2012 and was timely filed under an extension on September 27, 2013.  The taxpayer later realized that it had erroneously calculated its Oklahoma sales factor and filed an amended corporation income tax return on September 27, 2016. Under Oklahoma law, the amount of a claimed refund cannot exceed the portion of the tax paid during the three years immediately preceding the filing of the claim. The issue in dispute was whether the tax for which a refund was claimed was deemed paid on the date the return was filed under extension (Taxpayer’s view), or the date the return was initially due without an extension (Tax Commission’s position). 

The court observed at the outset that nothing in the law prescribed when taxes are considered “paid.” As the statute was susceptible to more than one reasonable interpretation, it was ambiguous.  Although a logical reading of the law supported a determination that taxes are paid when tendered to the Commission, all parties agreed that the taxpayer’s estimated payments were simply deposits to be applied against a future liability. The court noted, however, the statute also made clear that at least 90 percent of a taxpayer’s total liability must be paid by the original due date of the return to avoid penalties. After examining all the relevant statutes and the federal rules, the court held that the taxpayer’s taxes were deemed paid when it filed its return on September 27, 2013 (the extended due date). This conclusion, the court noted, was best able to harmonize the various authorities and was consistent with the federal refund scheme, which included the extension period for filing an income tax return. Please contact Asad Markatia with questions on In the Matter of the Income Tax Protest of Raytheon Company. 

Washington State: City’s B&O Apportionment Adjustment Upheld

Download PDF

Recently, the Washington State Court of Appeals, Division II affirmed the City of Tacoma’s interpretation of the B&O Tax apportionment statute in effect for the 2013-2017 tax years at issue.  The taxpayer provided management and administrative services to medical professionals from its offices in Tacoma, Tennessee, and Texas. For the years at issue, it apportioned its receipts to Tacoma using a two-factor payroll and service income method. Most of the taxpayer’s customers were outside the City, and the taxpayer computed a service income factor that was nearly zero.  The City argued that because many of the taxpayer’s business activities did not require direct customer contact, apportionment of the service receipts based on customer contact did not reflect a fair apportionment of its service income.  As such, the City applied a costs of performance approach, which increased the taxpayer’s B&O liability. The taxpayer disagreed with this adjustment. After a trial court ruled in the taxpayer’s favor, the City appealed.   

The issue before the court on appeal as whether the City’s apportionment statute provided a “cascading hierarchy” of sourcing methodologies, or whether it provided equal alternatives for determining a taxpayer’s service income factor. Under the statute in effect for the tax years at issue, there were three options for sourcing service income. Under the first, service income was in the City if the customer location was in the City. Under the second, service income was in the City if the income-producing activity was performed in more than one location and a greater proportion of the service-income producing activity, based on costs of performance,  was performed in the City than in any other location, and the taxpayer was not taxable at the customer location. Finally, service income was in the City if the service-income-producing activity was performed within the City, and the taxpayer was not taxable in the customer location. Each method was separated by the disjunctive “or.” “Customer location” means “the city or unincorporated area of a county where the majority of the contacts between the taxpayer and the customer take place.” The taxpayer, relying on an appeals court decision from another division, argued that the options had to be applied as a cascading hierarchy and that the second and third options applied only if the taxpayer had no customer contacts to establish customer locations.  The court disagreed. In its view, the statute set forth three alternative methods of apportioning, allowing the tax authority to select the method that most fairly and accurately apportioned service income. The court reasoned if the location of the customer was the determinative factor, the subsequent provisions would only apply when a customer location was not determinable, and such an interpretation would render the “not taxable at the customer location” language within those provisions superfluous and meaningless.  The taxpayer also argued that the costs of performance method could not be applied in any event as it was “taxable in the customer’s location” because those jurisdictions had the constitutional authority (as opposed to the legislative authority) to tax its gross receipts. The court pointed out that every taxing jurisdiction in the country has the constitutional authority to tax gross receipts, therefore the language at issue would be rendered meaningless if the taxpayer’s interpretation were applied. Accordingly, the court concluded that there must be an explicitly authorized gross receipts tax at the customer location for a taxpayer to be considered taxable.  Lastly, the court determined that the City’s apportionment method was both internally and externally consistent and therefore did not violate the commerce clause. For questions on Sound Inpatient Physicians Inc. please contact Michele Baisler.