California Tosses Tax Suit Against Online Travel Companies

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By Michael J. Bologna

Dec. 12 — The California Supreme Court granted a major victory to online travel companies in their ongoing battle with municipal revenue agencies, finding that the e-commerce companies bear no liability for millions of dollars in purportedly unpaid hotel occupancy taxes ( In re: Transient Occupancy Tax Cases , Cal., No. S218400, 12/12/16 ).

But the court on Dec. 12 also opened the door to a new strategy by which California municipalities may seek relief for potentially hundreds of millions of dollars in lodging taxes. The unexpected language caused attorneys acting as special counsels to the City of San Diego to assert the court has directed municipalities to seek recovery for unpaid taxes from the owners and operators of hotels.

“In my view, the OTC’s won the battle, but lost the war,” Gary Cruciani, a special counsel on behalf of San Diego, told Bloomberg BNA. “There is nothing to prevent San Diego, using this opinion, to sue the hotels.”

Cruciani, a principal in the Dallas office of McKool Smith, added that the OTCs would have to absorb some of the pain in any successful litigation targeting the hotel industry. He noted all of the major hotel chains have for many years required the OTCs to enter into agreements to protect against adverse tax rulings.

San Diego Assessment

In a widely anticipated ruling, California’s high court refused to endorse the City of San Diego’s $21.2 million assessment against several OTCs for allegedly unpaid transient occupancy taxes (TOTs). Among other things, the court found no basis by which the OTCs could be characterized as “hotel operators” under the TOT statute, leaving their so-called “mark up” fees exempt from taxation.

At first blush, the unanimous ruling was seen as a major win for Expedia Inc., Orbitz LLC, Priceline.com Inc. and Travelocity.com LP, which have been forced to defend their business model in dozens of courtrooms across the country. The central question in almost every case involves whether the hotel booking companies should pay hotel occupancy taxes on the higher retail rate paid by consumers, or the discounted wholesale rate negotiated between OTCs and hotels.

While the California high court holds OTCs harmless for any additional tax liability, it clarified that any costs added to the wholesale price of a hotel room remains taxable under the TOT and the liability rests with the hotel operator.

“We conclude that under the San Diego ordinance, in a ‘merchant model’ transaction of the sort at issue here, the operator of a hotel is liable for tax on the wholesale cost plus any additional amount for room rental the operator requires the OTC to charge the visitor under what have been termed the ‘rate parity’ provisions of hotel-OTC contracts but, as San Diego has effectively conceded, OTCs are not operators within the meaning of the ordinance,” the court wrote.

The “rate parity” provision discussed by the court relates to agreements preventing OTCs from charging customers a rate less than the hotel quotes on its own website. By creating such rate parity terms, the court said hotels are effectively charging the retail amount, “whether or not it ultimately receive or collects any portion of the markup, and that amount is therefore subject to the tax.”

Cities Seek Unpaid TOT

Cruciani said this language creates an avenue by which municipalities can seek millions of dollars in unpaid TOT. He noted there were dozens of California cities and counties “waiting in the wings” for the court’s ruling.

“We are encouraged by the decision,” he said. “It resolves in our favor the main issues which is what amount is subject to tax. Armed with that decision, whether it comes directly from the hotels or indirectly via the indemnity agreements with the OTCs, this will result in some substantial tax revenues being realized by the cities across the state.”

Both Expedia and the Travel Technology Association declined to comment on the ruling, stating it is a matter of pending litigation.

Michael Colantuono, special counsel to the California State Association of Counties, characterized the ruling as a mixed bag for municipalities. He said counties may go after hotels under Cruciani’s theory of the ruling. At the same time, they will have to adjust their statutes to try to capture the full tax obligations owed them going forward.

“My prediction is that the industry and hotels will collaborate to change the terms of their private agreements to escape the tax,” he said.

Hotel Council of San Francisco criticized the ruling as an “inequitable two-tier tax system that favors online travel companies over hotel companies.”

The council added, “the ruling puts the burden of tax collection on hotels for bookings made by online travel companies, giving those companies special status from paying the taxes that often fund what attracts visitors to California cities.”

To contact the reporter on this story: Michael J. Bologna in Chicago at mbologna@bna.com

To contact the editor responsible for this story: Ryan C. Tuck at rtuck@bna.com

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