On July 7, 2020, The DC Council incorporated into Mayor Muriel Bowser’s proposed Fiscal Year 2021 (FY21) budget a new three percent tax on “Advertising Services” (AST) during its first reading. Originally proposed by At Large Councilmember David Grosso (I) as an amendment, it was incorporated into the FYI 2021 Budget by Council Chair Phil Mendelson. The DC Office of the Chief Financial Officer projected the new levy would raise approximately $18 million.
Under the July 7 legislation, the “Advertising Services” subject to the three percent are defined as “the planning, creating, placing, or display of advertising in newspapers, magazines, billboards, broadcasting, and other media, including, without limitation, the providing of concept, writing, graphic design, mechanical art, photography, and production supervision.” The gross revenue produced by each individual service and advertising product is subject to the three percent levy.
The AST levies a three percent tax on the gross value of each stage of the creation and sale of advertising. Therefore, the tax accumulates, a.k.a. ‘pyramids,’ as it moves through the advertising production chain from creation of the creative to its publication.
The Pyramid in Action
According to Attorney Charlie Kearns of Eversheds Sutherland LLP, “The Council’s proposed tax on advertising services would apply at each stage of the advertising process, resulting in multiple layers of tax – or ‘pyramiding’ of tax – and taxation of business inputs, which is horrible tax policy.”
Stephanie T. Do, a Tax Counsel for the Council On State Taxation (COST) agrees. Unlike a sales tax, “this is taxing the same process multiple times,” Do states.
Suppose, ACME advertising agency is paid by Theater C to create an ad campaign. ACME hires a photographer, a web designer, a social media expert and printer to create materials. Each of the subcontractors charges $100 for their services. Each is subject to a three percent tax on the gross value of their contract. Each decides to pass the cost through. So, the tax increases the entire cost of the subcontracts by $12 or $412.
Now, ACME buys $500 of advertising space. Each of the media outlets is subject to a three percent tax on the sale of their advertising. They pass this through to ACME for an additional increased cost of $35. ACME passes the cost of the subcontracts through to Theater C, $947 adding its own management fee of $500 plus the three percent advertising tax for a total of $1,490.41.
Had there been no AST, Theater C would have paid ACME $1,400. With the AST, the cost of the same contract increased by six percent.
“Because the advertising tax would apply at each stage of the process,” according to Kearns, “whether directly by including the tax on the customer’s invoice or indirectly through increasing prices to economically recover the tax, the effective rate for the purchase of an advertising service could be much higher than the three percent nominal rate.”
“Alternatively, if the tax is not recovered (passed through to a client), its cost eats away at profits, which would be exceptionally harmful to the District’s small businesses, or it results in reduced advertising budgets,” Kearns points out.
The Problems with Pyramids
“Only three states tax advertising services,” Kearns says, “because of its significant economic impacts, not to mention advertising taxes are very difficult to administer.”
The tax is “inherently unfair,” states Do. If a firm is vertically integrated incorporating all advertising services and production, it will pay a different effective rate than a firm employing subcontractors, since it is not paying a three percent levy at each point in the advertising chain.
“The proposed sales tax on advertising services is poorly structured, because the District’s sales tax – like other retail sales taxes – is meant to apply only to the final consumer,” Kearns agrees.
It is unlike the Value Added Taxes (VATs) common in Europe, Kearns points out. “A typical VAT is imposed on taxable turnover, the increased cost at each stage of production, so the result is essentially the same as the retail sales tax, except an incremental tax is collected along the way.”
Europeans, Kearns says, adopted these “protections because business-to-business service transactions, like advertising services, should not be subject to tax in the first place.”
“If those services are subject to tax,” Kearns advises, “the law should provide an exemption for wholesale, or so-called sales for resale, transactions. The Council’s advertising tax proposal does not.”
Unintended Ripple Effects
While most of the public discussion concerning the AST has focused on its impact on the bottom lines of local newspapers, in fact, the effects of the new levy are likely to ripple throughout the economy.
Advertising pervades the DC economy. According to both Do and Kearns, the tax would be levied on the gross revenues of the sale of ads sold to support nonprofit arts and school galas. Theaters would be taxed on ads in their programs. Restaurants would pay for revenues derived from ads on menus. The sale of stadium naming rights and billboards would be subject to AST as well as sponsorships on WAMU and WPFW. This would offer a significant incentive to relocate in neighboring jurisdictions.
All DC businesses would have to also figure out how to report and remit the AST to the DC Office of Tax and Revenue on some sort of a periodic basis. Records would have be kept for audits. There is a cost for all of this paperwork.
The Council will vote on the FYI 2021 Budget during a second reading on July 21, 2020.