Maryland Comptroller Interprets Taxable “Digital Products” to include Almost Everything

March 16, 2021

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.”  Sellers of digital products have virtually no time to prepare for the collection of the new tax, as legislation enacted by an override of the governor’s veto takes effect 30 days after the veto is overridden. Thus, the taxation of digital products in Maryland began on March 14, 2021. Although the language of the law is seemingly very similar to those in other states that tax digital products, the Comptroller has issued guidance that includes a very broad interpretation of the term “digital product.”

Not surprisingly, the term “digital product” includes the sale of downloaded movies, music, video games, books, newspapers, and magazines. Online subscriptions to these products are also included in the definition of “digital product.”  For example, a monthly charge for a music streaming service or television streaming service is subject to sales and use tax.  This would include popular services such as Spotify, Netflix, and Hulu. Although the imposition of sales tax on these services will not be a welcome addition to the prices paid for these products and services by Maryland customers, they are at least services or products that are otherwise taxable when sold through other mediums. For example, cable television is subject to a franchise fee, whereas the sale of movies (e.g., DVDs), music, and books sold on a tangible medium are already subject to sales tax.

However, the Comptroller’s office has issued an interpretation of House Bill 932 (Business Tax Tip # 29), which makes the term “digital product” much broader than the definitions used in other states. For example, electronically delivered software and software-as-a-service have been interpreted to fall within the definition of “digital product.” Further, the Comptroller has listed the subscription to access content online, such as customer lists, mailing lists, and medical records, as now being subject to Maryland’s sales tax.  Although many other states impose sales tax on electronically delivered software and the software-as-a-service, most states do so through separately enacted provisions dedicated to addressing the taxability of software. Still, the Comptroller’s interpretation of House Bill 932 to include electronically delivered software and software-as-a-service does not appear to be too egregious, as software can reasonably be viewed as a “product.”

It’s also true that many other states tax access to content, but those states generally view this as a “service” and not a “product.” Thus, a state that taxes access to content (i.e., information) generally enacts a specific provision into its sales tax laws whereby “information services” are subject to tax.  Therefore, although a number of states may impose a sales tax on both “digital products” and “information services,” the taxation of an information service is done in a more transparent manner through specifically dedicated rules.  Jurisdictions that tax “information services” in this way include New York and Washington, D.C.

The Comptroller’s interpretation of “digital product” goes even further.  Business Tax Tip # 29 also lists the following in its non-exclusive list of “digital products”:

  • design files, models, and templates, such as 3D design files, 3D models, CNC templates, and virtual/alternate reality templates
  • 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

The concern with including these items in the definition of “digital product” is that the delivery of these services in person or in a tangible medium is not otherwise subject to Maryland sales and use tax.  For example, the Comptroller states that “a charge for viewing or attending continuing education classes” and a “charge for viewing a course or lecture online by a college or graduate school is subject to the sales and use tax.” From an enforcement perspective, the Comptroller’s broad interpretation of “digital products” to include services such as online classes may violate federal law. Similar to Maryland’s embattled Digital Advertising Tax, the Comptroller’s interpretation to include online classes and design files in the definition of “digital products” could result in Internet Tax Freedom Act (ITFA) violation claims.  As described by the Congressional Research Service, ITFA’s ban on discriminatory taxes “prohibits additional taxes or an alternative tax rate on a good, service, or information delivered electronically that would differ from the tax or rate applied to the same, or similar, good, service, or information if it were purchased through traditional commerce.”

The Comptroller, more or less, admits that its interpretation would violate ITFA’s ban on discriminatory taxes. Business Tax Tip # 29 provides that “a charge for attending a continuing education class, seminar or conference in-person is not subject to sales and use tax.” The Comptroller goes on to state that there is “no exemption from sales and use tax under Maryland law for the sale of a digital product on the basis that the product would have been exempt from sales and use tax if it had been delivered in tangible form or by other means.”  Although this may be true, the Supremacy Clause of the U.S. Constitution generally provides that federal law preempts state law when there is a conflict between the two. Such a conflict clearly seemingly in this case, as ITFA’s ban on discriminatory tax on e-commerce does not allow for different tax treatment of electronically delivered services (e.g., online classes v. in-person classes).

While the novel digital advertising tax recently enacted by Maryland received most of the immediate attention in the press and now in court, the expansion of Maryland’s sales tax to digital products could face similar controversy.  The difference here is that the controversy is being caused by an overly broad interpretation of the statute whereas the digital advertising tax on its face has a number of issues. It will be interesting to see if the Comptroller continues to apply this broad interpretation of “digital products.” For now, it’s safe to say that your Netflix binge-watching just got a bit more expensive.

If you have questions about Maryland’s imposition of sales tax on digital products, please contact your Aronson tax advisor or Michael L. Colavito, Jr.