For almost a year, Gov. William Donald Schaefer campaigned for a sweeping package of tax reforms that included expanding the sales tax to providers of services. But by the end of the legislative session in April, the General Assembly had rejected the entire package.
This week, Noble Steed Associates Inc., a Baltimore advertising agency, appealed a Maryland Tax Court ruling that the agency believes could create judicially the services tax the legislature rejected.
The state comptroller's office disputes the significance of the case, filed in the Baltimore County Circuit Court, arguing that the taxes it demanded of Noble Steed have been legitimate parts of Maryland's tax law for years. And Stephen M. Cordi, director of the comptroller's Sales and Use Tax Division, says that if the ad agency wins on appeal, Maryland could end up losing millions more dollars of tax revenue at a time when it can't afford to lose a dime.
"The Maryland sales tax is an extraordinarily narrow base," Mr. Cordi said. Sales and use taxes declined 1.9 percent from fiscal 1990 to fiscal 1991, the first time that had happened in more than a decade. And that's a major reason why Maryland faces a fiscal 1992 budget deficit of about $450 million.
The Noble Steed case resulted from the state's attempt to collect five years of taxes on some of the services and products the agency ordered from printers, photographers, musicians and others who helped produce ad materials.
Ordinarily, Maryland's tax law exempts sales of professional services, such as law, accounting and advertising. Even when certain tangible objects are sold as part of those services, they can't be taxed if the sale is "an inconsequential element for which no separate charge is made."
For instance, if an accounting firm charges a client for a management audit, the cost of that transaction can't be taxed, even if a glossy report changes hands. Noble Steed argued that when it purchased audiocassettes or videotapes from independent contractors, what it really purchased was the non-taxable service of producing those tapes, and not the physical tapes themselves.
At stake for the agency is "tens of thousands of dollars" in back taxes and penalties from 1983 through 1987, said Gene Suliga, a part-owner of Noble Steed.
The agency also argues that when it performed services for non-profit clients, such as the Johns Hopkins Health System, payments Noble Steed made to graphic artists and video producers to create a public relations campaign should be tax-exempt because the ultimate client is exempt from taxes. And if Noble Steed is "cloaked" by the tax-exempt status of its client, Mr. Suliga said, so should the businesses from which the agency buys services.
But the tax court ruled against Noble Steed on both counts. The ad agency could not be considered "an agent" of Johns Hopkins, and therefore included in Hopkins' tax-exempt status, because "Hopkins lacked the expertise to develop a public relations program and it could not have controlled or directed the development of the program."
Further, the court said, the recordings and artwork Noble Steed bought from independent producers are taxable because they are "specific tangible products." The transactions weren't simply service contracts, according to the court, because "the skills of the artists involved would be useless to Noble Steed without the end product of those services."
As Mr. Cordi explained it, "the taxability of a videotape that you buy in a store for $10 or one you hire somebody to produce for $10,000 is the same. . . . Records are taxable, but if Frank Sinatra gets on the phone and sings 'Strangers in the Night' to you, there's nothing to tax."