4th Circuit Remands Md. Ad Tax Challenge to District Court

The 4th U.S. Circuit Court of Appeals returned a U.S. Chamber of Commerce challenge of Maryland’s digital ad tax to a state district court. In an opinion Wednesday (case 22-2275), the appeals court agreed with the U.S. District Court in Baltimore (case 21-cv-00410) that the Tax Injunction Act (TIA) prevents federal courts from reviewing the tax. However, it disagreed that a decision on the constitutionality of a related pass-through ban was moot.

Earlier, the district court dismissed a challenge to the tax’s ban on passing through the tax’s costs to consumers due to the Circuit Court of Anne Arundel County ruling that the entire act establishing the tax was unconstitutional (see 2212050048). But the Maryland Supreme Court later overturned the state trial court’s decision (see 2307120062), saying the challengers in that case -- Comcast and Verizon -- failed to exhaust administrative remedies.

The state trial court’s declaratory judgment didn’t “necessarily moot this case because there was an impending appeal which could (and ultimately did) vacate the judgment, making the federal case live again,” 4th Circuit Judge Henry Floyd wrote: The challenge to the pass-through ban “is unquestionably live now that the Maryland Supreme Court has vacated the judgment that had declared the Act unconstitutional.” Judges Julius Richardson and Toby Heytens joined the opinion.

Maryland Attorney General Anthony Brown (D) “will continue to defend this transformative legislation and still believe[s] in the validity of this law,” he said in a statement. “The purpose of the digital ad tax is to provide critical funding to improve Maryland’s public education system and prepare our students to compete in the global marketplace.”

The Chamber is "pleased" with the ruling "and the opportunity to continue to defend businesses’ right to tell their customers about how this surcharge is affecting the price for digital advertising services in Maryland," said Jennifer Dickey, litigation center deputy chief counsel.

The Computer and Communications Industry Association, a co-plaintiff in the Chamber’s lawsuit, is “encouraged” that the 4th Circuit agrees constitutional review is required, said President Matt Schruers. “Digital services make a critical contribution to local economies by enabling local businesses to connect with customers and singling them out for punitive taxation is unwise and unlawful.”

The 4th Circuit disagreed with the Chamber that the appeals court should resolve the challenge itself. "The district court in the first instance should decide whether the pass-through provision restrains speech and, if so, whether it passes constitutional muster,” wrote Floyd. A facial challenge requires proving there are no circumstances in which the law would be valid, the judge said. "Those sorts of circumstances are best considered by the district court with the benefit of further fact-finding potentially.”

Maryland has a tax, not a punitive fee, so the TIA prevents federal court review, the 4th Circuit ruled. The court said a three-prong test from the 4th Circuit's 2000 ruling in Valero Terrestrial v. Caffrey confirms it’s a tax. "A charge is more likely a fee than a tax when an administrative agency imposes the charge, when a very small population of regulated persons or entities is subject to the charge, and when it is placed in a 'special fund to defray the agency’s regulation-related expenses,’” wrote Floyd. But here, the Maryland General Assembly, not a regulatory agency, created the charge, the judge said. "While the population subject to the charge is certainly not universal," the Chamber said that many of its members would be liable to pay, he said. And the money will go to state educational improvements, Floyd noted. "True, that is not a mere siphoning into the state’s general fund, but the revenue will benefit the population at large by giving every public school district in Maryland additional funding.”

However, the district court shouldn’t have entered the dismissal as a judgment “with prejudice,” the court ruled. “Because the TIA bar constituted a jurisdictional defect, the dismissal should have been ‘without prejudice’ so that the Plaintiffs could challenge the tax in the appropriate forum (the state’s administrative agencies and courts).”

The district court was correct that the TIA doesn’t bar challenging the pass-through ban, said the appeals court. It disagreed with Maryland that the challenge to the ban was so intertwined with the challenge to the tax that TIA also barred it. “The pass-through provision merely targets he manner and means by which the taxed companies pay for the tax," wrote Floyd. "Whether that targeted activity is best understood as speech or conduct should be considered by the district court in the first instance.” If a court decided that the pass-through ban was unlawful, it wouldn't stop the state from levying the tax.