Senator Steven Glazer, chair of the California State Senate Revenue and Tax Committee, is treating data like the next gold rush and taking bold steps to mine this new vein of wealth with his proposed “Digital Data Extraction Tax Law.” While couched as a tax on “data extraction,” the base for the tax is digital advertising revenue. The draft proposal contains several gaps, including the tax rate and effective date, and we understand that Senator Glazer is not certain he will file it.

Senator Glazer modeled his proposed tax on Maryland’s digital advertising gross receipts (DAGR) tax approach but with a twist, aligning it with Tennessee’s digital barter tax proposal (House Bill 2234/Senate Bill 2065). While California’s bill attempts to cure the numerous legal infirmities present in Maryland’s DAGR tax, it suffers from many of the same fatal weaknesses.

LEGISLATIVE BACKGROUND

The bill’s stated intent is to tap into the supposedly “enormous economic rents” that the “largest” internet companies generate from the personal data they “extract” from their users. The draft bill would introduce a new tax on gross receipts from the sale of digital advertising services (digital ad tax). The digital ad tax would be imposed on persons engaged in “digital data extraction transactions,” defined as transactions where:

(i) a person sells advertisers information about or access to users of the person’s services, [and]

(ii) the person engages in a digital barter by providing services to a user in full or partial exchange for displaying advertisements to the user or collects data about the user.

Under the bill, persons with digital advertising revenue above a certain level would be deemed engaged in taxable activity. Additionally, the digital ad tax would only apply to persons with advertising revenue above a certain (currently unspecified) level but would provide a carve-out for news media entities. Revenue from the tax would be earmarked for a fund that supports local newspapers.

A troubling feature of the draft bill is its sourcing regime. The bill would require that those subject to the digital ad tax use personally identifiable information about those to whom the ads are served to source revenue from the advertising to either California or somewhere else. Specifically, the bill requires that sellers of digital advertising services capture and retain information, such as users’ GPS locations or IP addresses. A seller would be required to produce this information to tax authorities on audit. These requirements raise profound privacy issues.

Perhaps recognizing the myriad of legal challenges faced by Maryland’s DAGR tax, California’s bill attempts to limit its application to entities based on their revenue derived in the state. It also attempts to ward off challenges that the digital ad tax is a discriminatory tax on electronic commerce barred by the Internet Tax Freedom Act (ITFA) by adding a bare statement that the “Legislature finds and declares . . . . [t]hat digital advertising is not substantially similar to traditional print or broadcast advertising” because those forms of advertising do not rely on “the extraction of valuable personal information from users” and do not “serve as a proxy for currently untaxed consumption.” The bill also does not appear to have a pass-through prohibition (an attempt to avoid a First Amendment challenge).

POTENTIAL LEGAL FLAWS

Nevertheless, the bill suffers from various potential legal infirmities. For starters, any court interpreting ITFA would be required to construe its terms under federal law, not state law. Moreover, the bill’s broad definition of “digital data extraction transactions” could encompass a wide array of online activities, raising questions about its scope and the administrative burden on businesses and the California Franchise Tax Board.

The bill couches the digital ad tax as on the putative “barter” that occurs when a consumer trades personal data for some free internet service, such as weather reports or driving directions. However, since the base for the tax is advertising revenue and not anything related to the values involved in the putative barter, the bill invokes the Supreme Court of the United States’ observation that “[a] tax on sleeping measured by the number of pairs of shoes you have in your closet is a tax on shoes.”[1] Such legal infirmities raise the question of whether the passage of this bill could create the same “fool’s gold” Maryland is harvesting with its DGAR tax.

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[1] Trinova Corp. v. Michigan Dept. of Treasury, 498 U.S. 358, 374 (1991), quoting Jenkins, State Taxation of Interstate Commerce, 27 Tenn. L. Rev. 239, 242 (1960).