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Groups representing major tech companies filed a lawsuit Thursday challenging Maryland’s new online advertising tax, contending it is an improper levy on the internet.

The suit in U.S. District Court in Maryland challenges the state’s recently enacted gross receipts tax on digital advertising revenue as unconstitutional and illegal under a federal internet tax moratorium.

The plaintiffs include the U.S. Chamber of Commerce, the Internet Association, NetChoice and the Computer and Communications Industry Association. Big tech companies including Facebook Inc., Alphabet Inc.’s Google unit and Inc. are represented by the groups.

The suit will be closely watched, as other cash-strapped states look to the burgeoning online economy as a new source of tax revenue.

Representatives of the tech companies contend that the tax will unfairly hit small businesses that depend on the internet during the Covid-19 pandemic.

“In light of the current pandemic and economic uncertainty, increasing taxes on services used by small businesses to keep themselves running is a particularly poor and ill-timed policy," said Caroline Harris, vice president for tax policy at the U.S. Chamber of Commerce.

But Maryland legislators who pushed for the tax argued that big online advertising companies haven’t been paying their fair share in the state.

“At a time when Maryland’s budget is being impacted in unforeseen and astronomical ways due to COVID-19, Maryland families and small businesses can foot the bill, or big tech can start paying their fair share," Maryland Senate Democrats tweeted a few days ago.

A number of states that have seen their revenues hit by the pandemic have begun to consider new taxes on aspects of the internet economy. That has the online advertising industry preparing to challenge efforts similar to Maryland’s in other states including New York, Connecticut, South Dakota and Nebraska.

“Any state that follows Maryland is on the same path to the courthouse," said Stephen Kranz, a lawyer with McDermott Will & Emery who is representing the business plaintiffs.

Supporters of the tax say it reflects the dominant role played by digital businesses in the economy.

“For two decades, these companies have grown exponentially by availing themselves of the privileges of states…and been free riders to Maryland’s investments in our civic infrastructure, Bill Ferguson, a Democrat and president of the Maryland Senate who introduced the bill, said in a statement.

Under the law, companies with annual gross revenue between $100 million and $1 billion globally will have to pay a 2.5% tax on their digital ad revenue in Maryland. Companies that make over $15 billion in global gross revenue a year will qualify for the top tax rate of 10% on ad revenue in the state. News and broadcast media companies are exempt.

Dan Jaffe, executive vice president of government relations for the Association of National Advertisers, said the law will be difficult to enforce, as technology companies that sell ad space typically don’t break out their revenue by state.

Instead, digital ads often target different groups of people around the country based on data about their personal traits.

The Maryland state comptroller will ultimately be responsible for tax collection services. The state has had conversations about using location-tracking techniques like geofencing and IP addresses that identify individual devices, Mr. Ferguson said in an interview.

“It’s complex and complicated and it is a new area," he said. “I imagine over time those regulations will have to adjust to the changing technologies."

Agencies that broker deals between advertisers and media companies are also unclear, based on the language in the bill, about whether they would be considered an ad seller, and thus get taxed, said Alison Pepper, executive vice president of government relations at 4A’s, which represents advertising agencies.

Mr. Ferguson said he doesn’t believe that a company reselling ad space to a marketer client would get taxed in addition to the company that sold the advertising real estate in the first place. The intention is to tax the digital company selling the original advertising space, he said.


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