Judge Probes Md. Motivations for Digital Ad Tax at 4th Circuit

The narrow targeting of Maryland’s so-called tax on digital ad revenue may suggest it’s primarily a punishment that federal courts are permitted to review under the U.S. Tax Injunction Act (TIA), 4th U.S. Circuit Court of Appeals Judge Julius Richardson said at oral argument Wednesday. The 4th Circuit is reviewing an appeal by the U.S. Chamber of Commerce of the March 2022 decision by the U.S. District Court in Baltimore to dismiss the Chamber’s challenge of the tax, plus the district court’s December dismissal of the Chamber’s challenge to the tax’s pass-through ban (case 22-2275). The 4th Circuit should remand all counts back to district court, argued the Chamber’s attorney Michael Kimberly of McDermott Will.

The Chamber argues the district court first erred when it said the TIA prevented it from reviewing the appellants’ constitutional and statutory challenges to the levy imposed by the tax (see 2301250023). The district court later was wrong to dismiss as moot its challenge to the tax’s pass-through ban due to a state court striking down the tax as unconstitutional, said the group with co-appellants NetChoice and the Computer and Communications Industry Association (CCIA) in their January brief. In July, the Chamber said the Maryland Supreme Court’s recent decision to overturn that lower court’s decision shows the federal case isn’t moot (see 2307200029 and 2307120062). However, Maryland argues the Maryland Supreme Court decision doesn’t matter because the TIA bars the Chamber’s entire action (see 2308020028 and 2302240047).

Richardson asked Maryland Assistant Attorney General Julia Doyle Bernhardt if she had “any other examples of Maryland taxes or fees that target companies” as narrowly as the digital ad tax. Bernhardt cited several, including gambling and tobacco taxes. Judge Toby Heytens said he would be surprised if he “didn’t learn that the number of people who paid those taxes every year dwarfs the number of entities” that would pay the digital tax. Richardson agreed, “If there aren’t other more similar taxes, it suggests that you’re really just trying to punish this … very narrow set of companies,” he said. "This ain't a tax, right? This is a hammer."

The court must look at the tax law itself -- not comments of legislators behind the bill -- to determine if it’s a tax or punishment, said the Maryland lawyer: The law says its purpose is to raise money for public school education. Richardson asked if that means the court must “ignore the reality of why this was enacted because they weren’t straightforward enough to put the reason in the statute?”

The Maryland law directs revenue to a fund that “has nothing to do with counteracting the effect of social media or anything else,” replied Bernhardt. The assessment satisfies a four-prong test for determining what is a tax from the 4th Circuit’s 2013 ruling in Liberty University v. Lew, she said: It’s a revenue-raising law that lacks a "scienter requirement," which refers to intent or knowledge of wrongdoing. The comptroller collects the tax through the normal system, and it doesn’t “punish any unlawful content,” she said. “It has none of the characteristics of a penalty,” regardless of any legislator’s possible “individual motivations.”

“We often look beyond the text to find purpose in statutes,” replied Richardson. “Maybe that's a good idea. Maybe it's not. But it doesn't seem unusual to do it here." If the court considers legislators’ comments about why they supported the bill, “do you agree that that’s fatal?” Bernhardt said, “I don’t know how you get there when you’re applying the [TIA], which is a jurisdictional rule.”

The TIA isn’t meant to protect penalties “dressed up in … the clothing of a tax” from federal review, said the Chamber’s Kimberly. The Maryland tax is “unusually burdensome” and “not within the range of normal,” he added. Plus, bill sponsor and Senate President Bill Ferguson (D) and some hearing witnesses cited Amazon, Facebook and Google by name as bad actors, said the lawyer: Those companies pay the most under the tax.

Heytens probed the law’s pass-through prohibition. If it’s permissible under the Maryland law for companies to increase customer bills to account for the tax as long as they don’t list it as a separate line item on the bill, “this is literally a prohibition on what they can say,” he said.

Kimberly said the pass-through ban violates the First Amendment by restricting how companies communicate the tax to customers. But Bernhardt said the law allows companies to make the tax “part of their overhead” and to provide information to customers about why their bills are higher, she said. “What the statute prohibits is the conduct of … billing the customer for the tax. In other words, you can’t … compete with other companies on the bottom-line price and then add the tax on separately at the end.”