Maryland’s sales and use tax was recently expanded to include the taxation of “digital products.” Despite the sale of products or services to the Federal Government (government) being exempt from Maryland sales and use tax, this change in Maryland cannot be overlooked by government contractors located in Maryland. Additional compliance requirements may be required to avoid paying Maryland sales tax on purchases of digital products when such products are being resold to the government. When the government contractor is the consumer of the digital product, the additional cost due to the purchase now being subject to sales or use tax needs to be accounted for in a contractor’s allowable costs under the contract.
On February 12, 2021, the Maryland General Assembly overrode the Governor’s veto of House Bill 932, making Maryland the most recent state to impose its sales tax on “digital products.” The law went into effect on March 14, 2021. The language of the law is very similar to those in other states that tax digital products. Thus, not surprisingly, the term “digital product” includes the sale of downloaded movies, music, video games, books, newspapers, and magazines.
However, the Comptroller has interpreted “digital product” in a way that makes the law change impact government contractors more than initially thought (See Business Tax Tip # 29). According to the Comptroller, the term “digital product” includes electronically delivered software, software-as-a-service, and subscriptions to access content online. These are products and services purchased by government contractors on a regular basis. Whether a government contractor will be required to pay Maryland sales when purchasing these items depends on whether the contractor will be using the digital product or reselling it to the government. This determination depends on the facts of the particular contract.
Generally, a government contractor must pay sales tax on purchases of items used in the performance of its services. This general rule stems from the principle that the government’s exemption from sales tax does not extend to independent contractors of the government. Whereas, if the government contractor purchases a digital product for purposes of reselling it to the government, the contractor’s purchase is an exempt sale for resale with the subsequent sale also being exempt due to the government not being subject to tax.
A government contractor that will be purchasing a digital product (e.g., software-as-a-service) in connection with a contract needs to make a determination as to the correct sales tax treatment when bidding on a contract. This will enable the contractor to account for the cost of the sales tax on digital products that will be used by the contractor in performing the contract’s services, or ensure that the tax is not included in any quotes when the digital product will be resold to the government.
From a compliance perspective, a government contractor that is subject to Maryland sales or use tax on its purchase of a digital product needs to ensure that either (1) its vendor is charging Maryland tax; or (2) when the vendor does not charge the tax, that has internal procedures in place to remit the tax to the Comptroller. When a government contractor is reselling the digital product to the government, to avoid being charged tax by the vendor, it must provide the vendor a resale certificate. Unlike most states that have a specific resale certificate form, Maryland only has a suggested format for a resale certificate that can be found here. It’s important to note that a valid Maryland resale certificate must include a Maryland sales and use tax registration number. Therefore, if you have never issued a resale certificate in the past, you will need to register for a Maryland sales and use tax account to obtain the registration number.
The Comptroller will likely be issuing regulations that will provide additional guidance on the taxation of digital products in Maryland. Maryland currently has very little guidance on the treatment of the sale of software and software-related services (e.g., maintenance and support). Government contractors impacted by Maryland’s taxation of digital products should consult with a tax professional to stay up to date on any developments in this area or to obtain assistance on making taxability determinations on specific purchases.
Contact an Aronson tax advisor at 202.770.4018 if you have any questions related to sales and use tax.