In this second of a three-part series, Breslow discusses the Internet Tax Freedom Act and whether the digital world has really been protected from the tax man.
Adoption and Intent of the ITFA
Initially adopted in 1998 under the Clinton administration with the mantra “no new internet taxes,” the Internet Tax Freedom Act (ITFA) was made permanent on February 24, 2016. In addition to placing a prohibition on taxes on internet access, the ITFA prohibits a state, or political subdivision of a state, from imposing multiple or discriminatory taxes on electronic commerce. “Electronic commerce” is defined as “any transaction conducted over the Internet comprising the sale of property, goods, [or] services.” In other words, the same tax rate must apply to items, regardless of whether they are purchased over the internet or through traditional commerce, such as at a brick-and-mortar store or by catalog.
Although the internet was only in its infancy when the ITFA was proposed, the Clinton administration and U.S. Congress shared concerns about a possible move by state and local tax authorities to target electronic commerce and internet access, as taxation could stifle the development of internet commerce. The concern is bolstered by the unique nature of the internet, which is indifferent to state borders and particularly vulnerable to regulatory burdens. This led to the adoption of the ITFA, the purpose of which was to prevent states from subjecting electronic commerce to multiple and discriminatory taxes across myriad state and local jurisdictions.
When the Permanent Internet Tax Freedom Act was passed as part of the Trade Facilitation and Trade Enforcement Act of 2015, the commissioner of the Federal Communications Commission praised the bill, stating:
This is a great day for American consumers. The U.S. Senate passed the Permanent Internet Tax Freedom Act with a strong bipartisan vote. This confirms a national consensus that state and local taxes on Internet access should be taken off the table once and for all . . . I hope the bill is enacted soon — Americans need and want the certainty that the digital world will be spared the taxman.
But intentions and effects are often incongruent, especially as the internet and technology progress, raising the inquiry: Has the digital world really been protected from the tax man?
Persuasiveness of ITFA in Court
The impact of the ITFA was demonstrated in Performance Marketing Association v. Hamer, in which the Illinois Supreme Court concluded that an Illinois act that imposed a tax collection obligation on retailers that engaged in online “direct marketing” via a link on an affiliate’s website violated the ITFA’s bar against tax discrimination. Performance marketing refers to marketing or advertising programs by which person or organization that publishes or displays an advertisement (referred to as an “affiliate”) is paid by the retailer when a specific action, such as a sale, is completed. Although these contractual arrangements are not limited to the internet, the court determined that the Illinois act targeted ou-tof-state internet retailers that enter into agreements with others for online performance marketing accomplished through a “link on the person’s website,” but did not impose a similar obligation on out-of-state retailers that enter into performance marketing contracts with offline Illinois print publishers and over-the-air broadcasters.
The ITFA defines a discriminatory tax as any tax imposed on electronic commerce that:
- i. is not generally imposed and legally collectible by such State or such political subdivision on transactions involving similar property, goods, services, or information accomplished through other means;
- ii. is not generally imposed and legally collectible at the same rate by such State or such political subdivision on transactions involving similar property, goods, services, or information accomplished through other means, unless the rate is lower as part of a
phase-out of the tax over not more than a 5-year period;
- iii. imposes an obligation to collect or pay the tax on a different person or entity than in the case of transactions involving similar property, goods, services, or information accomplished through other means; [or]
- iv. establishes a classification of Internet access service providers or online service providers for purpose of establishing a higher tax rate to be imposed on such providers than the tax rate generally applied to providers of similar information services delivered
through other means.
Therefore, under the ITFA, a tax is discriminatory if similar property, goods, services, or information are taxed when purchased electronically but not when purchased offline, or when the tax on electronic purchases is imposed at a different rate or on different persons.
The Illinois Department of Revenue conceded that the Illinois act made no mention of traditional, “offline” performance marketing contracts, but nevertheless argued it was not discriminatory because other statutory provisions imposed a use tax obligation for offline performance marketing. The flaw with the department’s position, however, was that although the Illinois act required out-of-state retailers that enter into performance marketing contracts with Illinois internet affiliates for the
publication of online marketing — which is inherently national or international in scope — to collect Illinois use tax, Illinois law did not require out-of-state retailers who enter into performance marketing contracts for offline print or broadcast advertising to collect Illinois use tax when disseminated nationally or internationally. Therefore, the Illinois act discriminated against retailers with internet performance marketing arrangements.
Although the department appealed the Illinois Supreme Court’s decision, the U.S. Supreme Court ultimately denied certiorari, seemingly empowering the ITFA in further disputes. However, did the ITFA provide longstanding protection for electronic commerce, or did it further muddy an already unclear tax landscape? Because the Illinois Supreme Court reached its decision on ITFA grounds, it failed to address whether the act violated the commerce clause of the U.S. Constitution, as lamented by the dissenting opinion. This lack of clarity resulted in subsequent decisions addressing electronic commerce in the scope of the commerce clause, including a recent loss by the taxpayers at the Illinois Appellate Court in Labell.
A Step Back — Recent Taxpayer Loss in Labell
Although the ITFA is frequently raised as a defense by taxpayers, the position is commonly dismissed by the courts and even abandoned by taxpayers. This is true for several individual plaintiffs who brought suit challenging the constitutionality of the city of Chicago’s amusement tax as it relates to internet-based streaming services. On appeal to the Illinois Appellate Court, the plaintiffs, who are residents of Chicago and subscribers to various streaming services, including Netflix, Hulu, Spotify, and Amazon Prime, argued that the application of the Chicago amusement tax to streaming services discriminates against electronic commerce in violation of the ITFA.
Because the ITFA prohibits the city from imposing taxes at a different rate on services provided over the internet than on transactions involving similar services provided through other means, the plaintiffs contended that the Chicago Amusement Tax Ordinance violates the ITFA. The plaintiffs argued that discrimination against electronic commerce occurs in two key ways:
- the ordinance requires customers of streaming services to pay the amusement tax, even though the ordinance entirely exempts users of automatic amusement devices from taxation; and
- the ordinance fully or partially exempts live theatrical, musical, and cultural performances at theaters and other venues from the amusement tax but taxes streaming services that provide access to similar or identical theatrical, musical, or cultural performances over the internet.
In reaching its decision that the ordinance does not violate the ITFA, the Illinois Appellate Court distinguished the holding in Performance Marketing, concluding that unlike performance marketing services, which are identical whether performed via the internet or over-the-air broadcasting, streaming services are not the same as automatic amusement devices or live cultural performances. In support of its conclusion, the court found that whereas streaming services are primarily used privately in the home or on devices owned and maintained by the patron, automatic amusement devices are used publicly, outside the home and are owned and maintained by businesses. The de minimis nature of the use by a public individual supports taxing the automatic amusement device annually. Further, the court held that in-person live cultural performances are distinct from performances delivered through streaming services because live performances encourage patrons to visit public spaces, where they can view the live cultural performance but also frequent other Chicago businesses such as restaurants, bars, and hotels.
However, the court’s analysis is troubling. A tax is discriminatory under the ITFA if it applies to electronic commerce but is not imposed on similar goods or services accomplished through other means. The court instead creates a higher burden that requires the streaming service be the “same” as its nontaxed counterpart. This requirement is absent from the ITFA. Alternatively, it is not difficult to imagine identical streaming services that could be disproportionately taxed. For example, if a Chicago theater with a capacity of fewer than 1,500 persons holds a live performance of Phoebe Waller-Bridge’s one-woman show Fleabag, Chicago amusement tax will not apply. Yet if that same content is available to users via a streaming service, the amusement tax will apply. The content being transferred is undeniably identical, yet following the court’s analysis, the activities are not the “same” for purposes of the ITFA because one is attended in person and will deliver value to local businesses and the other will not. To require that entertainment viewed electronically be exactly the same as entertainment performed live, including its having the same impact on the community, naively ignores the inherent differences created when a service is delivered electronically.
What’s Next for the ITFA?
Another Look at Streaming Services in Apple
Although the Illinois Supreme Court denied Labell’s petition for leave to appeal on March 25, the saga is not over, as Apple is also challenging the application of the Chicago amusement tax to its music streaming services on several grounds, including the ITFA. The matter was stayed until Labell was decided, but now, pending COVID-19 delays at the Cook County circuit court, it will proceed. Because Apple Music and Spotify (at issue in Labell) are arguably comparable streaming music services, the Chicago Department of Law views the cases as raising the same issues. Can Apple overcome this negative precedent?
The circuit court may reach a different result in Apple if the focus returns to the intent of the ITFA: to protect internet commerce from being stifled by taxation. With the advent of the internet, arts and entertainment services are received differently, but the function of the content is unchanged. What happens when products and services, such as streaming music platforms, exist only in the context of electronic commerce? As technology advances, the focus should not be on whether the service provided in electronic commerce is the same as its brick-and-mortar counterpart, but rather on whether it serves a similar purpose or function. Here, the purpose of Apple Music and a live musical event is similar, as subscribers or attendees seek to discover and listen to music. The spirit of the ITFA is violated by assessing tax on these innovative streaming services.
Also, by focusing on streaming music only, Apple may have an advantage over the plaintiffs in Labell, which challenged streaming television, movies, and music. Whereas the content streamed on Hulu or Netflix is clearly distinguishable from a live performance of a play, because there is no live equivalent to a television show, a song streamed on Apple is no different from a song performed in person. The goods transferred, including the lyrics and notes, are identical; it is merely accomplished through other means. Without the distractions of several forms of streaming media, which are arguably more difficult to compare and identify in the factual record, the court may reach a different result when the focus is narrowed to streaming music.
Protection From the Digital Advertising Tax?
The latest test for the ITFA is several states’ proposal of a tax on digital advertising. State governments are prohibited from imposing discriminatory taxes directly on online activity, yet this is what legislatures have recently attempted to accomplish in several states, including Maryland, Nebraska, and New York. Likely inspired by a broader 2018 European Union initiative to tax digital business activities, Maryland led the pack with legislation, proposing a “digital advertising gross revenues tax” on January 8.
However, unlike its European predecessor, the recent state legislation was hastily drafted and has drawn ire for violating the ITFA. The most evident issue with Maryland’s proposed H.B. 732 is that it targets digital advertising, as opposed to traditional advertising conducted via any other medium. The bill would impose a tax on the annual gross revenues of a person that are derived from “digital advertising services” in the state, which includes “advertisement services on a digital interface, including advertisements in the form of banner advertising, search engine advertising, interstitial advertising, and other comparable advertising services.” Accordingly, because Maryland does not have a complementary tax on traditional advertising services not conducted over the internet, it arguably violates the ITFA.
Supporters of the bill have defended its constitutionality by arguing that taxing digital advertising services does not amount to a discriminatory tax on electronic commerce because the sale need not be “conducted over the Internet” for the proposed tax to apply. Applying the definition of “electronic commerce,” is the “transaction conducted over the internet” the transmission of the advertising services or the purchase of the advertising services? The Maryland Attorney General focuses on whether the purchase of the advertising is made over the internet, as advertising could be purchased over the phone or by mail. However, this interpretation is at odds with the purpose of the ITFA, which is to widely protect electronic commerce and the internet, not online shopping specifically.
Alternatively, if the focus is on the transmission of the digital advertising, how else will targeted consumers view banner and search engine advertising, if not over the internet? This digital advertising appears on websites and requires the internet for the users to click and interact. Further, unlike its print ancestor, digital billboards are generally connected to the internet to not only control and monitor the content, but to track the consumers using identification numbers from cellphones. Despite sidestepping the “internet” within the specific language of the bill, because digital advertising and the internet are so intertwined, the proposed bill places the burden of tax compliance on sellers of digital advertisements, while sparing sellers of traditional print advertisements from compliance.
If Maryland elects to proceed with ratifying the bill, it should consider making changes to avoid a likely challenge under the ITFA. The state could modify or expand its definition of digital advertising services so that it would apply regardless of whether the services are conducted over the internet. However, this may be a herculean task because the internet and digital advertising are so heavily intertwined. Whereas traditional, non-digital advertising generally reaches the masses using a “spray-and-pray” approach, digital advertising targets consumers using consumer data derived over the internet, such as clicks or impressions. Alternatively, the obvious solution is for the state to target gross revenues from all advertising services, rather than targeting digital advertising services. As advertising moves online, the state could reach digital advertising revenue without specifically targeting it.
Although taxpayers frequently raise the ITFA as a defense with limited results, the stage is set in favor of not only another ITFA challenge, but potentially a win. Issues unexplored by the Illinois Appellate Court in Labell have arguably left a window open for Apple’s pending challenge to the application of the Chicago amusement tax to streaming services. Further, if the Maryland, Nebraska, or New York legislatures proceed with proposed legislation, it is likely that the ITFA will protect digital advertisers from the tax man, invalidating a tax on digital advertising as a discriminatory tax on electronic commerce preempted by the ITFA.
 Internet Tax Freedom Act, P.L. 105-277, section 1100, 112 Stat. 2681-719 (1998); and P.L. 114-125, section 922(a), 130 Stat. 281 (2016) (codified at 47 U.S.C. section 151).
 Although currently a prohibition, when the Permanent ITFA was passed in 2016, six “grandfathered states” were given temporary authority until July 1, 2020, to continue administering previously adopted taxes on internet access. ITFA section 1104.
 ITFA section 1101(a).
 ITFA section 1105(3).
 Verenda Smith and Lee A. Sheppard, “The Price of Internet Tax Freedom Then and Now,” Tax Notes State, Aug. 26, 2019, p. 806; and S. Rep. No. 105-184, at 7 (1998) (discussing S. 442, the Internet Tax Freedom Act).
 Brief of Chris Cox et al. as amici curiae supporting respondents, South Dakota v. Wayfair Inc., 138 S. Ct. 2080 (2018) (No. 17-494).
 Performance Marketing Association v. Hamer, 998 N.E.2d 54 (Ill. 2013). P.A. 96-1544 (the Illinois act) amended the definition of a retailer or serviceman “maintaining a place of business” under the Illinois Use Tax and Service Use Tax acts to include a “retailer having a contract with a person located in this State under which the person, for a commission or other consideration based upon the sale of tangible personal property by the retailer, directly or indirectly refers potential customers to the retailer by a link of the person’s Internet website.” Pub. Act 96-1544, section 5 (eff. Mar. 10, 2011) (codified and repealed at 35 ILCS 105/2(1.1)).
 Id. at 56.
 Id. at 58-59.
 ITFA section 1101(a), 1105(2)(A).
 Id. at 58.
 Critics of the decision argue that the statutes tax advertising similarly, and any disparate treatment is not the fault of the taxing
regime but is because the two forms of advertising are substantively different.
 Id. at 64.
 The ITFA was initially raised in Normand v. Wal-Mart.com USA LLC, No. 2019-C-263, and posed by an amicus brief in Wayfair, but it was ultimately abandoned by the taxpayer. Brief of Chris Cox et al., supra note 6.
 In June 2015 the Chicago City Council issued Ruling 5, which clarified that the city’s amusement tax applies to charges paid for the privilege of watching electronically delivered television shows, movies, or videos and for the privilege of listening to electronically delivered music and participating in games, online or otherwise, when delivered to a customer in the city. Chicago Amusement Tax Ruling No. 5 (eff. July 1, 2015). On Nov. 21, 2017, the City Council amended the ordinance to add as a taxable category of activity “paid television programming, whether transmitted by wire, cable, fiber optics, laser, microwave, radio, satellite or similar means.” M.C.C. section 4-156-010.
 In addition to challenging the ordinance on ITFA grounds, the plaintiffs also argued that the tax on streaming services: (1) exceeds the city’s authority to tax under the Illinois Constitution Art. VII, and (2) violates the uniformity clause of the Illinois Constitution of 1970. Labell v. City of Chicago, 2019 IL App. (1st) 181379, P15, 59.
 An “automatic amusement device” is defined as “any machine, which upon any payment method, may be operated by the public
generally for use as a game, entertainment or amusement and includes but is not limited to such devices as jukeboxes, marble machines, pinball machines, movie and video booths or stands and all [similar] games, operations or transactions.” M.C.C. section 4-156-050. Automatic amusement devices are taxed at a flat rate of $150 per year, as opposed to other amusements, which are taxed at a rate of 9 percent of receipts. M.C.C. section 4-156-060 and section 4-156-070.
 Although the ordinance imposes amusement tax on a “musical or spectacular performance,” it exempts “in person live theatrical, live musical or other live cultural performances that take place in any auditorium, theater or other space in the city whose maximum capacity, including all balconies and other sections, is not more than 1500 persons.” M.C.C. section 4-156-010 and section 4-156-020(D)(1).
 Labell v. City of Chicago, 2019 IL App. (1st) 181379, P60.
 Id. at 47.
 Id. at 50.
 ITFA section 1101(a), 1105(2)(A).
 Labell v. City of Chicago, 2019 IL App. (1st) 181379, P65.
 For readers sheltering in place, Fleabag is available to stream online at http://ondemand.sohotheatre.com.
 Who is to say I won’t place a takeout order from my local guinea pig café?
 Labell v. City of Chicago, 2020 Ill. LEXIS 314.
 On January 8 the circuit court continued Apple Inc. v. City of Chicago, 2018-L-050514 (2018), to April 23, 2020, pending the decision in Labell v. City of Chicago, 2020 Ill. LEXIS 314.
 “Chicago Department of Law spokesman Bill McCaffrey told Tax Notes, ‘The issues raised in Apple’s complaint are the same as those raised in a previous case in which the circuit court ruled in the city’s favor, upholding the city’s amusement tax as applied to video and audio streaming.’” Andrea Muse, “Apple Challenges Chicago Tax on Streaming Services,” State Tax Notes, Sept. 3, 2018, p. 1019.
 If a brick-and-mortar store charges customers a fee to browse and select music from a robust record collection, without purchasing the music, would this be a similar or identical service to Apple Music? Arguably no, because not only does Apple Music allow users to listen to the content in varied and unlimited environments, but the platform offers far more value in terms of curated playlists, organized content by category, and updated music recommendations based on user activity.
 In its appeal, the plaintiffs addressed Netflix, Hulu, Spotify, and Amazon Prime. Labell v. City of Chicago, 2019 IL App. (1st) 181379, P6.
 Although a “musical or spectacular performance” is subject to tax as an amusement, it is not imposed on all musical performances, as the ordinance exempts “in person live theatrical, live musical or other live cultural performances that take place in any auditorium, theater or other space in the city whose maximum capacity, including all balconies and other sections, is not more than 1500 persons.” M.C.C. section 4-156-010 and section 4-156-020(D)(1).
 On January 14 Nebraska introduced L.B. 989, which seeks to expand the state’s sales tax base to include the retail sale of “digital advertisements,” which means “an advertising message delivered over the Internet that markets or promotes a particular good, service, or political candidate or message.”
 On March 13 the New York Senate introduced S. 8056, which proposes to impose an annual tax on any person deriving gross revenues from digital advertising services in the state. The term “digital advertising services” includes “advertisement services on a digital interface, including advertisements in the form of banner advertising, search engine advertising, interstitial advertising, and other comparable advertising services, that use personal information about the people the ads are being served to.” Then on April 13, 2020, New York introduced S. 8166, which proposes to expand the state’s sales and use tax to digital advertising services, such as banner advertisements, search engine advertising, “interstitial advertisements,” and other comparable services. A digital advertising service subject to the tax would be one that “markets or promotes a particular good, service, or political candidate or message.”
 Although originally proposed in S.B. 2/H.B. 695, the digital advertising tax language was later added to H.B. 732, which passed the legislature on March 18. H.B. 732 is under review by Gov. Larry Hogan (R), who is expected to veto the bill. However, the legislature can override the governor’s veto by a three-fifths vote in both chambers. Elke Asen, “Digital Services Taxes in Europe,” Tax Foundation (Mar. 16, 2020).
 H.B. 732, section 7.5-101(D).
 In Maryland, an advertising agency provides nontaxable advertising services when the transaction with the client is for (a) the
preparation and placement of advertising in print or broadcast media, (b) public relations, (c) setting up press conferences, (d) conducting market research, or (e) creative concept design. Md. Regs. Code 03.06.01.38(A)(1). However, an advertising agency sells taxable tangible personal property when the transaction is for the production and transfer of specific property that the client uses, such as signage, letterhead stationery, business cards, brochures, flyers, or displays. Md. Regs. Code 03.06.01.38(A)(2).
 Letter from Maryland attorney general’s office to Sen. Andrew Serafini (R), “Re: Senate Bill 2 — Digital Advertising Gross Revenues — Taxation” (Feb. 7, 2020); and ITFA section 1105(3).
 “Electronic commerce” is defined as “any transaction conducted
over the Internet comprising the sale of property, goods, [or] services.”
ITFA section 1105(3).
 Thomas Germain, “Digital Billboards Are Tracking You. And They
Really, Really Want You to See Their Ads,” Consumer Reports (Nov. 20,
 Indrajeet Deshpande, “What Is Digital Advertising and Getting
Started as a Digital Advertiser,” MarTech Advisor (Jan. 31, 2019).