Articles

Client Alert: Maryland’s Digital Products Tax Will Impact Everyone

Effective March 14, 2021, the Maryland General Assembly overrode Governor Larry Hogan’s veto and enacted a digital products tax as part of the “21^st Century Economy Fairness Act” (the “Act”). See House Bill 932 (2020 Legislative Session). Simply stated, the Act extends Maryland’s existing 6% sales and use taxes to digital goods.[1]

Prior to this, the Maryland sales tax applied to the sale of tangible personal property and certain services. While enactment of the Act arguably was intended to align Maryland sales tax law with the law in 30 other states regarding sales of digital products, the Act has far-reaching consequences. The Act extends sales and use taxes to a number of products including, but not limited to, the following digital products if obtained or delivered by electronic means:
 

• E-books, newspapers, magazines, periodicals, or any other publication;
• A digital download or stream of a motion picture, music video, news and entertainment program, live event, sporting event, tutorial, etc.;
• A digitized sound file that may be downloaded onto a device and may be used to alert the user to a communication or information (ringtones);
• A sale, subscription or license to access content online; and
• A sale, subscription or license to use a software application.

 
The Maryland Comptroller issued Business Tax Tip #29 (the “Tax Tip”), that identifies additional items that it contends are taxable under the Act if obtained or delivered by electronic means:
 

• Access to a chat room, discussion, weblog, or any other venue that permits users to communicate electronically in real time
• An online class, instruction, or similar product
• Access to or use of video or online games
• Access to or use of virtual items, such as skins, renders and in-app purchases, purchased for use in a video or online game
• Audio or video greeting cards sent by email, text or any other electronic means
• Customer lists, mailing lists, medical records, and similar products
• Design files, models, and templates, such as 3D design files, 3D models, computerized numerical control (CNC) templates, and virtual/alternate reality templates
• Photographs, artwork, illustrations, graphics and similar products
• Prerecorded or live music
• Prerecorded or live performances
• Prerecorded or live audio books or other written materials
• Prerecorded or live speeches including commentaries, dissertations, and lectures

 
The Act’s Impact on M&A, Remote Learning and Software
 
Readers will note that included in the above-list are “customer lists” and “online class,” two significant changes that will impact the largest of Maryland entities as well as the youngest and least financially stable individuals.
 
As noted above, historically, Maryland’s sales and use tax applied primarily to the sale of tangible personal property. In the context of corporate acquisitions structured as asset sales, parties would typically exchange customer lists strictly in digital format, thereby limiting the Maryland sales tax bill to amounts allocable to any furniture, fixtures and equipment, and sundry other hard assets, that may have been acquired in the transaction. Now, any parties engaged in an asset acquisition where the buyer has a “primary use” address in Maryland (further explained below), must plan to include Maryland sales tax in its transfer tax provisions and the seller must file a sales tax return with the state.
 
Prior to the Act, Maryland sales tax was generally not imposed on college tuitions. As a result of the Act, now it appears that Maryland-resident students who may enroll in college to receive their education remotely, must pay Maryland’s 6% sales tax on top of their tuition. The Tax Tip specifically provides that “A charge for viewing a course or lecture online by a college or graduate school is subject to the sales and use tax.” However, per a footnote in the Tax Tip, “it is unclear from the legislative history or the statutory language whether charges for tuition at a college or graduate school are subject to sales and use tax if the school either partially or wholly delivers lectures electronically.” 
 
Similarly, Maryland residents who may enroll in continuing education classes remotely must also pay sales tax; per the Tax Tip: “A charge for viewing or attending continuing education classes, seminars or conferences provided electronically are subject to sales and use tax even if sold by a non-profit or tax-exempt organization.” 
 
Additionally, many businesses purchase or access software electronically, including software as a service (commonly referred to as SaaS), which are now subject to tax under the Act.
 
Don’t Forget About Use Tax
 
The Act will also impact out-of-state persons who bring their digital products into Maryland, because of the existing use tax provisions of Maryland sales tax law. Generally, use tax is the equivalent of a sales tax on purchases made outside of Maryland for taxable items that will be used, stored or consumed in Maryland when they are not taxed (or were taxed at a lower rate) in the state of purchase. So, for example, if a non-Maryland limited liability company moved its headquarters into Maryland, it would be required to pay a use tax to the state on any digital goods it acquired in a lower-taxed acquisition.
 
Beware of Bundled Transactions
 
Under the Tax Tip, “a bundled transaction is the retail sale of two or more items if the items are not separately stated and sold for one price, including tangible personal property, taxable or non-taxable services, or a digital product. The entire charge for a bundled transaction that involves the sale of a digital product and a non-taxable service or non-taxable tangible personal property is subject to the sales and use tax. However, the sales and use tax does not apply to a charge for a personal, professional, or insurance service that is not a taxable service but involves a sale of digital product as an inconsequential element for which no separate charge is made.”
 
The Rules for Sourcing Digital Sales
 
The sale of digital products is presumed to have occurred in the state of the “customer’s tax address”.
The Tax Tip details the following hierarchy for determining a customer’s tax address:

1. The address of the vendor’s business location if the digital product is received by a buyer at the business location of the vendor;

2. The address of the primary use location if the buyer does not receive the digital product at the vendor’s business location and the vendor knows the primary use location of the digital product;

3. If item 1 and item 2 do not apply, the location where the digital product is received by the buyer or by a donee of the buyer if identified by the buyer and if known to the vendor and maintained in the ordinary course of the vendor’s business;

4. If items 1 through 3 do not apply, the location indicated by an address for the buyer that is available from the business records of the vendor that are maintained in the ordinary course of business, if the address does not constitute bad faith;

5. If items 1 through 4 do not apply, the location of the address of the buyer provided during the consummation of the sale, including the address of the buyer’s payment instrument, when use of the address does not constitute bad faith; or

6. If items 1 through 5 do not apply, including a circumstance in which a vendor does not have sufficient information to apply those items, one of the following locations as selected by the vendor, provided that the location is consistently used by the vendor for all sales to which this item applies:
   - The location in the United States of the headquarters of the vendor’s business;
   - The location in the United States where the vendor has the greatest number of employees; or
   - The location in the United States from which the vendor makes digital products available for electronic transfer.

“Primary use location” means, for an individual, the street address of the actual end-user of a digital product. If the buyer is not an individual, then the “primary use location” is the location of the buyer’s employees or equipment that makes use of the digital product.

For out-of-state vendors, according to the Tax Tip, Maryland’s Wayfair nexus standard applies. See Maryland’s Tax Alert regarding remote sales and economic nexus and COMAR 03.06.01.33(B)(4)-(5) for more information.
 
Final Thoughts
 
The authors expect the Act and the Tax Tip will likely give rise to legal challenges, including whether the Act conflicts with the federal Internet Tax Freedom Act, the commerce and due process clauses to the U.S. Constitution, and whether the breadth of the Tax Tip in terms of what is considered taxable exceeds the authority of the Act.  At this time, however, readers are advised to ensure compliance with the Act and Tax Tip and monitor further developments.
 
Attorneys at Whiteford, Taylor & Preston are available to answer your questions about these latest developments.