Online travel industry, local governments duke it out over occupancy taxes

A storm has been brewing between state and local tax officials and the online travel industry for the last several years over hotel occupancy taxes. From New York to San Francisco, Washington to Georgia, states and cities have taken companies like Orbitz, Travelocity and Expedia to court for what has been characterized as stealing, tax fraud, and dishonest business practices.

Amid a growing rash of courtroom struggles in the last five years, a body of evidence has revealed how online travel companies make their profits and conduct their business. State and local officials believe they are being short-changed on hotel occupancy taxes, but they are working with outdated ordinances and ambiguous definitions with which to force full payment.

States and cities are now considering alternatives to their hotel tax laws to be inline with the Internet age. Definitions on “room remarketers” and “accommodations intermediaries” are being written into the new laws, but online travel companies are moving to counter these changes with federal legislation.

Under the terms of draft legislation, companies like and Hotwire would be exempt from paying their share of taxes on the retail rate of hotel room bookings. State and local officials say the exemption would be a preemption of their rights and question why this industry should be allowed to set its own tax base. Hotels, meanwhile, benefit from bookings made through companies like Expedia, but are strongly opposed to federal legislation for fear of being left with the state and local tax tab.

This tête à tête between local government officials and the online travel industry is nearly a decade old with hundreds of millions of dollars at stake. Hotel occupancy taxes, also known as transient occupancy taxes, are a major source of revenue for local governments. According to a 2008 hotel industry economic impact report, from American Economics Group, Inc, nearly $12.5 billion in occupancy and related sales taxes were collected that year. And a large portion of that money is redirected to fund tourism costs, such as convention centers, historic preservation, and visitor centers. The report also estimates 25 percent of all hotel taxes go directly to tourism marketing efforts, which can have powerful multiplier effects on a region’s economy.

“Hotel taxes…provide state and local governments with a reliable and necessary funding source,” reads a letter from a coalition of public sector advocacy groups to the Senate Finance Committee in January 2010 (more on the nature of this letter in part two of this series).

That funding source, as it turns out, could be millions short of what is owed. State and local government officials argue there is a gap between taxes owed and the actual amount being remitted by online travel companies, or OTCs.

First defined in 2000, OTCs use what is referred to as “the merchant business model.” According to a June 2000 Securities and Exchange Commission filing from Expedia, the company “acquires inventory at discounted wholesale prices from preferred suppliers and then determines the retail price.” OTCs then collect all funds from the consumers at the time rooms are booked, including taxes and fees. But they only remit taxes based on what it owes the hotel, rather than what it collected from the consumer.

A typical example involves a $100 hotel room and a 10 percent occupancy tax. If the room is bought through the Sheraton’s website, the traveler pays $110, $10 of which is remitted to the government as the hotel tax. But if the room is bought through Travelocity, for example, and the wholesale rate was set at $80, the customer still pays $110, but only $8 is sent to government, leaving Travelocity with $22 in profit.

The remittance gap is the central point of conflict between governments, nationwide, and the online travel industry. This gap could be worth as much as $258 million to state and local governments per year, says one report by the Center on Budget and Policy Priorities.

This issue began reaching critical mass around 2008 with suits being filed by hundreds of cities in Ohio, Texas, California, Kentucky, New York, Washington, New Mexico, Illinois and elsewhere. In most of the lawsuits, governments were trying to obtain back-taxes to the tune of millions. Many of the cases resulted in dismissals because most hotel tax laws and ordinances were adopted before the advent of the Internet. OTCs have been characterized in court as intermediaries or remarketers of hotel rooms, so they fall in a grey area and are not liable to collect taxes, many courts have ruled.

In what some perceive as a landmark case – or at least a deviation from dozens of other cases – San Antonio, Texas led a 172-city strong class action suit requiring a jury to consider whether OTCs were “controlling hotels” under the Cities’ hotel occupancy tax ordinance. Past cases usually relied upon the court to make that decision. In October 2009, the jury concluded that the answer was yes, and ordered Expedia, Orbitz, Travelocity and to pay over $20 million in back taxes. A similar ruling was made last year in Anaheim, California who won $21.3 million in back taxes, interest and penalties – though it has since been overturned by an appeal.

The fight made national headlines in 2009 when Columbus, Georgia – home of Aflac Insurance and the Army’s Fort Benning – successfully won its case against OTCs in the state’s Supreme Court. But as the Wall Street Journal and USA Today reported, Columbus, GA then found itself “delisted” from major OTC search results. Instead, travelers who wished to stay in the Georgia border town were pushed across state lines to look for lodgings in Phenix City, Alabama. Expedia vice president Brent Thompson said the local government in Columbus did it to themselves, telling the WSJ, “They have forced themselves out of the largest travel channel in the world.” This example has since been portrayed as a warning to small(er) towns who dare to go at OTCs on their own.

Given the mixed track record of relying on outdated ordinances and to bring hotels into the conversation, some cities are trying to craft new ones.

In 2009, New York City passed an ordinance that forces OTCs to collect occupancy taxes on the full amount paid by consumers. The new law adds definitions to the existing law to include “room remarketers”, “net rent” and “additional rent.” Additionally, it makes room remarketers collect taxes based on the additional rent and remit those taxes to the Commissioner of Finance – a move that ensures only OTCs are responsible for the taxes above the hotel contract rate (the $22 in the earlier example). The NYC ordinance has served as a guide for other jurisdictions, but it also illuminated the strength and organization of the OTCs’ industry trade group, the Interactive Travel Services Association.

According to a source with the American Hotel & Lodging Association – the national organization for hoteliers – hotels are worried about additional tax burdens, but they are also worried that OTCs can use their rooms against them. When rumor spread about NYC amending its hotel tax ordinance, the ITSA circulated form letters indicating their displeasure with NYC’s proposed ordinance change. They drafted the letter, from a hotel manager’s perspective, asking them to sign it and send it to their councilmember. There is nothing particularly unusual about this practice, the source said. But the ITSA also included a note, which indicated they were keeping track of which hotel managers passed along the note and which ones did not.

“There is a perception from hoteliers that they better comply or else a 3rd party can come in trying to bludgeon them with their rooms, over someone else’s actions,” the source said.

After the ordinance passed city council and was signed by Mayor Bloomberg, NYC was sued by several OTCs in late 2009 on constitutional grounds. The case is still pending.

Washington, D.C., is mirroring the NYC example on proposed legislation. Introduced by Councilmembers Michael Brown, Jack Evans, Kwame Brown and Chairman Vincent Gray, the bill would mandate that online travel companies pay the full amount of tax “on the amount paid by the occupant” of a hotel room.

States join the fray

Individual cities and counties are not the only ones waging battles against OTCs, there is a small, but growing, amount of state-level action. In fact, given the vulnerability of smaller cities and towns, some believe that state legislation could be a more effective tool. Last year, Florida’s Attorney General decided to voyage down the road of litigation, meanwhile members of the Florida House attempted to pass their own version of exemption legislation. The bill has since stalled and the lawsuit is pending decision.

But in North Carolina, industry and government advocates alike are waiting to see how a newly enacted budget bill will be handled come January 2011. Yesterday, July 6, N. Carolina enacted an appropriations bill, which contained several provisions relevant to OTCs. Under the new rules, room “facilitators” (OTCs) are responsible for remitting taxes based on the sales price of a room, which includes, “facilitation fees and any other charges necessary to complete the rental.” According to the budget bill’s provisions,  OTCs are required to comply beginning January 1, 2011. The state estimates a revenue increase of $1.7 million, given these new changes.

The Commonwealth of Virginia has also made some headway in addressing the issue. Companion bills were unveiled this year by Sen. Mary Margaret Whipple and Del. Robert Brink in the Senate and the Assembly. The bills would largely adopt similar concepts, differentiating between hotels and OTCs by introducing new definitions and allowing all cities and counties within the Commonwealth to do what NYC and the District are attempting. Although the House bill failed soon after its introduction, SB 452 passed the Senate unanimously last spring, and received a unanimous vote in a House Finance Subcommittee before being considered by the full Finance Committee.

According to Sen. Whipple and several sources familiar with SB 452, the legislation had been well received by others when time was allocated to understand the complex issue. But after learning about the Senate bill’s quick and unanimous passage, the ITSA dispatched one of its chief lobbyists to Richmond to quell action in the House. Questions of “unintended consequences” – especially for smaller hotels in resort towns – were raised after a weekend break allowed the OTC lobby to advocate their position. But according to Sen. Whipple, the legislation had been crafted with them specifically in mind and she said the hotel industry had voiced their support for changes.

SB 452 was tabled by the full committee and is currently being studied by the Department of Taxation – a move designed to give some deference to the subcommittee who voted unanimously to pass it.

Moving forward, advocates for hotel occupancy tax changes argue a strong need for hotel industry involvement. Hotels largely reject the idea of federal legislation, but they fear that state and local governments, due to the harsh economic conditions of the last two years, will pursue these taxes at any cost – sticking hotels with the bill if necessary. And they have good reason to worry.

In April 2010, the San Francisco Treasurer & Tax Collector sent a letter to area hotels, making them jointly responsible for the full amount that hotel guests pay to the OTCs. The AHLA fear this will happen in many cities, counties and states if federal legislation is enacted.

In the second piece of this series, CivSource will look at proposed federal exemption legislation, its history and the likelihood of future passage.