Dissecting Maryland’s Sales Tax on Digital Products: Part 1-What is a Taxable Digital Product?

October 22, 2021

Earlier this year, the Maryland General Assembly overrode the Governor’s veto of House Bill 932 (The 21st Century Economy Fairness Act), resulting in the retail sale of a digital product being subject to the state’s sales and use tax effective on March 14, 2021. Maryland is not alone in expanding its sales and use tax base to include the taxation of digital products. In fact, it’s rather late to the game in that regard. Well over 20 states were already taxing digital products at the time Maryland changed its rules. However, Maryland’s approach is somewhat unique in that the legislation, and subsequent guidance issued by the Comptroller, reflect that the scope of the term “digital product” is somewhat broader than the meaning used by many other states.

This article is the first in a series that will address a number of important aspects of Maryland’s taxation of digital that both sellers and buyers of digital products should not overlook. This first article will be somewhat introductory in nature and will generally summarize what is and what is not a digital product as well as how the taxation of digital products impacts sellers of non-taxable services that may include certain electronically delivered components to those services.

As noted above, as of March 14, 2021, Maryland’s sales and use tax applies to the sale of a digital product, regardless of whether the digital product is sold to the customer with rights of permanent use or less than permanent use (i.e., a rental) as well as sold as a subscription to access or stream the product. Maryland’s sales and use tax law broadly defines “digital product” as a product that is obtained electronically or delivered by means other than tangible storage media using technology having electrical, digital, magnetic, wireless, optical, electromagnetic, or similar capabilities, and includes:

  • A work that results from the fixation of a series of sounds that are transferred electronically, including prerecorded or live music or performances, readings of books or other written materials, and speeches;
  • Audio greeting cards sent by e-mail;
  • A digitized sound file such as a ringtone, that is downloaded onto a device and may be used to alert the user of the device with respect to a communication;
  • A series of related images that, when shown in succession, impart an impression of motion, together with any accompanying sounds that are transferred electronically, including motion pictures, musical videos, news and entertainment programs, live events, video greeting cards sent by e-mail, and video or electronic games.
  • A book, generally known as an “e-book,” that is transferred electronically; and
  • A newspaper, magazine, periodical.

Products and services that clearly fall within this definition include:

  • Downloaded music and movies
  • Streaming music services
  • A movie rental that is accessed electronically
  • Streaming television program services
  • Video games, including console games and mobile device games
  • Ring tones
  • E-books
  • Electronically delivered periodicals
  • Electronic greeting cards

However, the Comptroller has interpreted the definition of “digital product” to include a number of items that arguably would not fall with the statutory definition. For example, the Comptroller, in Business Tax Tip # 29, has indicated that a taxable “digital product” includes (i) the sale of or access to certain data or information; (ii) electronic communications, such as a charge to access a chat room; and (iii) the sale of electronically delivered canned software, including Software-as-a-Service (SaaS).

Although a number of states impose their sales tax on these items, notably information services and SaaS, most of them do so under separately enacted sales tax provisions. Aprio addressed this in more detail in a previously published blog. For example, the Comptroller’s interpretation of “digital product” to include electronically delivered software appears questionable. This seems as if the Comptroller is trying to fit a square peg in a round hole. None of the bullets reflected above that encompass what the general assembly has enacted as being considered a “digital product” appear broad enough to include software.  Our second article in this series will address the Comptroller’s guidance on the taxation of SaaS “digital product.”

Complexities can arise when a service provider that generally performs a nontaxable service delivers a component of such service electronically. Maryland, like most other states that impose a sales and use tax, does tax professional service such as those provided by physicians, lawyers, accountant and engineers. Of course, these service providers routinely deliver their work product electronically. To ensure that such services remain nontaxable, the general assembly added clarifying language in the definition of “digital product” providing that a digital product does not include a professional service obtained electronically or delivered through the use of technology.

Generally, so long as any digital product that may be delivered in connection with a nontaxable service remains an immaterial (i.e., “inconsequential”) element of the service, all of the fees charged by the provider will remain not subject to tax. For example, the fees charged by an attorney for drafting a legal memorandum for a client are not subject merely because the memorandum is provided to the client electronically in the form of an email attachment. Here, the dominant purpose of the transaction is for the attorney to provide nontaxable legal services to the client and not a digital product.

However, there are certain instances when a digital product can be provided in conjunction with a nontaxable service where the digital product is not an inconsequential element of the overall transaction. Under Maryland’s rules, when the price for taxable and nontaxable elements of a sale are not separately stated on a customer invoice (i.e., the sale is a “bundled transaction”), the entire charge is subject to sales tax. For example, a marketing firm engaged to develop a brand marketing campaign for a business and also provide signage, business cards, and digital artwork and graphics could be seen as a taxable “bundled transaction” if the fees for the various elements of sale are not separately stated on the customer invoice.

Determining when a digital product is no longer an inconsequential element of the sale is somewhat subjective. Thus, when in doubt, it’s advisable for a seller to separately itemize the different components of the overall sale, and charge sales tax on the items that are taxable digital products.

Contact Aprio’s State and Local Tax (SALT) Services team today to connect with an experienced advisor. 
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