Maryland enacts digital products sales tax exclusions: PwC

In brief

Maryland legislation enacted on May 29 excludes from taxable “digital products” certain computer software or software as a service (SaaS) purchased or licensed solely for commercial purposes in an enterprise computer system. The legislation also excludes certain digital products in which the purchaser has an intellectual property interest. The legislation, enacted without the signature of Gov. Larry Hogan (D), is effective July 1, 2022. [S.B. 723/H.B. 791, enacted 5/29/22]

For consideration: The legislation provides some clarity for sellers and purchasers of computer software and certain business-to-business services that include a digital product component to the transaction. However, because the legislation has a prospective effective date, this clarity will not help for periods dating back to the March 14, 2021 effective date of Maryland’s digital products sales tax.

In detail

The legislation excludes two new categories of products from the definition of taxable digital products.

Enterprise computer software: Computer software or software as a service purchased or licensed solely for commercial purposes in an enterprise computer system. Such software includes operating programs or application software for the exclusive use of the enterprise software system. The software may be housed or maintained by the purchaser or on a cloud server, whether hosted by the purchaser, the software vendor, or a third party.

Observation: The Maryland Comptroller last summer issued revised guidance regarding amendments to Maryland’s digital products sales tax, including an expansion of the state’s custom software exclusion. The Comptroller’s interpretation stated that nontaxable customized, configured, or modified software “is software that does not operate immediately as required by the buyer (i.e., ‘out of the box’) and includes enterprise software.” However, SaaS remains taxable under the Comptroller’s interpretation unless the exclusion for custom software applies. (See PwC’s Insight on the Comptroller’s revised guidance.) This legislation provides further grounds for seeking to exclude software used on enterprise systems and may remove some uncertainty regarding what constitutes sufficient customization or configuration to qualify for the custom software exclusion.

Digital products in which the purchaser has an intellectual property interest: Products having electrical, digital, magnetic, wireless, optical, electromagnetic, or similar capabilities, where the purchaser holds a copyright or other intellectual property interest in the product (in whole or in part), and the purchaser uses the product solely for commercial purposes such as advertising or other marketing activities.

Observation: The Comptroller’s interpretation of the digital products law raised concerns regarding its breadth and specifically its potential application to business-to-business services that involve digital products. One example raised by stakeholders has been advertising and marketing services. This legislation addresses this concern by excluding digital products in which the purchaser holds an intellectual property interest. In addition, this exclusion is not limited to use of the digital product in advertising and marketing, but rather extends to any use that is solely for commercial purposes.