Maryland’s General Assembly has enacted House Bill 791, which narrows the scope of digital product sales that are subject to the state’s sales and use tax. The bill became law on May 29, 2022 after the 30-day review period ended with no action taken by the Governor. The legislation amends the sales and use tax law to specifically exclude the following from the definition of a taxable “digital product”:
- An electronically transmitted product in which the purchaser holds an intellectual property interest when the product is used solely for commercial purposes, such as in advertising or other marketing activities
- Computer software or software as a service purchased or licensed solely for commercial purposes in an enterprise computer system
These exclusions, which take effect on July 1, 2022, come a little over a year after Maryland began imposing its sales and use tax on the sale of digital products. The legislation will likely be warmly received by the business community because it eliminates the additional cost of sales or use tax on the purchase of certain business inputs for companies that are based in the state of Maryland. These exclusions are arguably consistent with the nature of a sales and use tax as being a tax that is only imposed on the ultimate consumer. For example, manufacturers are generally not subject to sales tax on the materials they purchase that become a component part of the products that they resell. The exclusions enacted by House Bill 791 are analogous to the manufacturing exclusion. For example, a service provider’s purchase of certain software products will not be subject to Maryland sales tax when the software is used to facilitate the performance of its services that it provides to its customers.
The two exclusions enacted as part of House Bill 791 are very different in terms of the types of purchases to which they apply. The first exclusion applies to a business’ purchase of rights to use items such as digital images, audio files, or audio-visual files for a business purposes. For example, if a business has licensed the right to use a song and the song is used in a marketing campaign, the cost to access the digital file of that song will not be subject to Maryland sales tax.
The second exclusion, which will impact a much broader scope of purchases, should apply to most software purchases made by businesses located in Maryland. The software exclusion excludes from the definition of “digital product” both purchases of downloaded software and software as a service whether the software is operating software or application software. Granted, some of the language in the software exclusion is a bit unclear. Specifically, the legislation provides that the exclusion applies to software purchased or licensed “solely for commercial purposes in an enterprise computer system . . . for the exclusive use of the enterprise software system.” The terms “enterprise computer system” and “enterprise software system” are not defined in the legislation. These terms are typically used when referring to software products deployed to a business’ employees for use in performing work related tasks.
It will be interesting to see if the Comptroller interprets these terms in a manner that may potentially limited the scope of the exclusion. For example, whether a license of software needs to be for a certain number of users in order to be considered “enterprise software” is one potential limitation. Further, a more obvious limitation in the software exclusion, as well as the intellectual property right exclusion, is a potential narrow interpretation of the requirement that the software must be used solely for “commercial purposes.” The term “commercial purposes” is not defined in the legislation. Organizations such as business associations and chambers of commerce, which are generally tax-exempt for income tax purposes, are not exempt from Maryland sales tax similar to charitable and educational organizations. Thus, the potential issue is whether or not these types of organizations use software for “commercial purposes.”
Presumably, the Comptroller, in response to House Bill 791, will update its digital products publication (Business Tax Tips #29) to provide clarity on some of these issues. Still, it is clear that most software purchases made by for-profit businesses will be exempt from Maryland sales and use tax beginning on July 1, 2022.
Learn more about Maryland’s taxation of digital products in the four-part series, “Dissecting Maryland’s Sales Tax on Digital Products”:
- Part 1: What is a Taxable Digital Product?
- Part 2: The Treatment of Software as a Digital Product
- Part 3: Some Continued Education and Nonprofit Organization Events are Taxable
- Part 4: The Tiered Approach to Sourcing Sales
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. at 301-231-6200.