Cities Square Off Against Internet Travel Providers Over Occupancy Taxes
By Laura K. Christa Founding Member, Christa & Jackson | October 2008
Across the United States municipalities are suing Internet travel companies including Orbitz, Expedia, and Travelocity over hotel bookings. The reason? What they claim is a substantial underpayment of occupancy taxes. Cities like Los Angeles claim that the online sites pay occupancy taxes to the hotels based on the discounted rate at which they purchase or arrange rooms for the hotel, not at the alleged "retail" rate that they charge the customer. They claim the difference can amount to millions that rightfully belong in city coffers. Are the lawsuits a slam dunk? Not according to the Internet companies. They claim they merely add a service fee to the room rate and pass that charge on to the customer.
1. Framing the debate: Wherein a travel agent becomes a travel merchant
In an amended complaint filed in February 2006 in the Los Angeles action, the City claims the websites operate in two ways: some it claims, purchase rooms and offer them for resale to their customers. Others "arrange" the reservation for their customers, informing the hotel of the booking and the customers' relevant information. In either case plaintiff's lawyer, Paul Kiesel, claims the occupancy taxes are owed on the rate ultimately charged the customer, not the lower rate at which the Internet travel companies contract with the hotel. He explains that transient occupancy tax ("TOC") statutes require the occupant to pay taxes based on the rate paid by the occupant. Similar lawsuits are currently pending in San Diego, Philadelphia and the city of Fairview in Illinois.
Art Sackler, the Executive Director of Interactive Travel Services Association ("ITSA"), an industry trade group that represents Orbitz, Expedia and other online companies, claims the suits are based on a misconception. He says that occupancy taxes are included in the hotel prices listed online, and are then passed on to the hotels, which are responsible for remitting the taxes to municipalities. He explains that there are two basic models used for Internet hotel sales. The first, an agent model, simply charges a rate for the hotel to which occupancy taxes are added. This model does not appear to be implicated in most of the lawsuits. The second, the "merchant" model, is the bigger target. Under that model, the hotel and the Internet travel company negotiate a rate for the hotel room. The online provider then adds a service charge to the room rate and offers it at that higher price to the consumers. Sackler explains that the added service charge should not be subject to occupancy taxes because it is not part of the room rate. The service charge reflects the costs associated with operating and marketing the Internet-based travel company.
How will this issue be resolved? A judge may try to compare the practices of Internet travel providers with the model of traditional travel agents, ignoring the "merchant" model, where the Internet travel company casts itself as a reseller that adds a service charge for the room. In such an analysis, a judge would focus solely on the room rate ultimately paid by the customer, and ignore any component claimed to be a service charge.
How are occupancy taxes paid on rooms arranged by traditional travel agents? Carole Friedman, a travel agent with Trident Travel in Los Angeles, explains that their agency does not charge service fees to the clients for whom it arranges hotel accommodations. They are paid a traditional commission, generally 8-10% of a hotel's published room rate, for introducing its clients to the hotels. So does the hotel pay occupancy taxes on the full rate paid by the customer, or the rate less the commission paid to the travel agent? James Abrams, the President and CEO of the California Hotel & Lodging Association, says it's the latter. "Hotels pay occupancy taxes on the entire amount the customer pays, including the commission."