A federal District Court in Tennessee and the Commonwealth Court of Pennsylvania have held that online travel companies (OTCs) that facilitate hotel reservations were not liable for local hotel occupancy taxes on the amount paid by consumers to book the rooms.1 Instead, the hotel tax was based on the amount paid as consideration to the hotel (the discounted price negotiated between the OTCs and the hotels). In both cases, pursuant to the applicable language in the tax ordinances, the tax only applied to a hotel "operator." Both courts determined that OTCs were not hotel "operators," and therefore were not subject to the local hotel occupancy taxes on the retail price of the rooms charged to the consumers.
Background
OTCs book hotel rooms and make other travel arrangements for customers over the Internet under what has been labeled the "merchant model" of business. OTCs first enter into contracts with individual hotels and negotiate a discounted rate for each hotel room, commonly termed the net rate. OTCs then offer reservations of the rooms to the public at the net rate, plus a service fee and/or a facilitation fee, and state and local hotel occupancy taxes (applied to the net rate). When a customer books and pays the total amount to an OTC, the OTC pays the net rate and hotel occupancy taxes to the hotel, and the hotel remits the taxes to the relevant states and municipalities.
Tennessee Decision
Procedural History
In 2008, Goodlettsville and other Tennessee municipalities joined in a class action suit against a group of OTCs2 in federal District Court. The complaint alleged that the OTCs violated various local hotel occupancy tax codes. In 2009, the District Court denied the OTCs' motion to dismiss the action against them.3 Subsequently, the parties each filed motions for summary judgment.
Applicable Tax Ordinance
The District Court examined Goodlettsville's ordinances in determining whether the OTCs properly collected the local hotel occupancy taxes at issue. A Goodlettsville ordinance imposed a tax upon the "privilege of occupancy in any hotel of each transient in an amount equal to three percent (3%) of the consideration charged by the operator."4
Analysis
In reaching its determination that the OTCs were entitled to summary judgment in their favor, the Court addressed its prior ruling against the OTCs. The Court had initially denied the OTCs' motion to dismiss the case in 2009 because of the allegations contained within the City of Goodlettsville's complaint. The complaint alleged that the OTCs took a "possessory" interest in the hotel rooms that were marketed through the OTCs' Web sites. However, after the discovery phase, the evidence showed the contrary. Based on the evidence, the OTCs "do not purchase or take title to hotel rooms and do not pay the hotels before a booking is made." Rather, the Court found that the OTCs merely contract for "the right to market an allotment of rooms."
Moreover, after the Court's denial of the OTCs' motion to dismiss in 2009, there have been a number of decisions establishing new legal precedent upon which the Court could rely.5 First, the federal Court of Appeals for the Sixth Circuit found that the OTCs in question neither exercised ownership nor physical control of the rooms they offered for rent in Kentucky.6 In addition, in response to the argument that ruling in favor of the OTCs would allow for a "loophole" in the application of hotel occupancy taxes, the Sixth Circuit stated that the Kentucky legislature could close such a "loophole" since it is not within the realm of the judiciary's authority to amend or create laws. Furthermore, the Sixth Circuit questioned whether a "loophole" even existed when it came to OTCs. Unlike a hotel evading full taxes by creating a shell company to which it sold rooms at a nominal rate, a hotel and an OTC normally do not share common ownership. The Sixth Circuit also pointed out that the language of the applicable ordinance was determinative. Where the ordinance expressly stated that tax applied to the "charge to the public" for a room, tax would apply to the retail rate. On the other hand, where the ordinance was not as explicit in stating that the tax applied to the charge made to the consumer, the tax would apply to the net rate charged to the OTC.
In addition to the Sixth Circuit decision, the District Court also considered the discrepancy in findings by a federal court and a state court within Texas as support for its conclusion that enough question or doubt exists with respect to the issue of whether tax applies to the OTCs' retail charge to consumers to warrant a ruling in favor of the OTCs. In Texas, a federal District Court jury found that the OTCs were "controlling hotels" under a statute that taxed entities that owned, operated, or controlled any hotel.7 Soon thereafter, the same issue was brought before a state court, the Texas Court of Appeals, and the opposite conclusion was reached.8
In this case, the District Court explained that the relevant ordinance was enacted prior to the Internet age, before OTCs came into existence, and the Court implied that the law had failed to take into account new business models and technologies. The tax ordinance imposed tax on the "consideration charged by the operator" and defined an operator as a "person operating the hotel whether as owner, lessee, or otherwise."9 Since the tax ordinance did not define the term "operate," the Court turned to dictionary definitions and concluded that the term strongly suggested that an entity must engage in the day8to8 day management of a hotel property in order to be deemed an "operator." Moreover, in light of the ambiguity, pursuant to the rules of statutory construction, the Court was required to construe the term "operate" strictly against the City and in favor of the OTCs. Therefore, the Court determined that the hotels were required to remit taxes only on the consideration they actually received. In other words, the tax applied to the net rate paid by the OTCs to the hotels and not to the retail rate paid by the consumer to the OTCs.
In addition, as the Sixth Circuit in Kentucky had maintained, the District Court pointed out that the hotels and OTCs were independent entities engaging in arm's length transactions. Thus, the threat of tax evasion, as may be the case with entities that create shell companies under the same ownership, did not apply. The Court noted that if the Tennessee legislature wants to tax the retail rate charged to consumers, it can do so through appropriate statutory language. Due to all of the foregoing reasons, the District Court granted summary judgment in the OTCs' favor.
Pennsylvania Decision
Procedural History
In 2010, the City of Philadelphia's Tax Review Board decided that an OTC, Expedia, Inc., was not subject to the City's hotel room rental tax because it was not deemed an "operator" of a hotel under the Philadelphia Code. In 2011, the Court of Common Pleas of Philadelphia County (trial court) denied the City of Philadelphia's appeal from the City's Tax Review Board decision. As a result, the City of Philadelphia appealed the matter to the Commonwealth Court of Pennsylvania.
Applicable Tax Ordinance
The Philadelphia Code imposes a hotel tax "on the consideration received by each operator of a hotel within the City from each transaction of renting a room or rooms to accommodate transients. The tax shall be collected by the operator..."10 The Code defines an operator as a person or entity or group of persons "who maintain, operate, manage, own, have custody of, or otherwise possess the right to rent or lease overnight accommodations in any hotel to the public for consideration."11
Analysis
The Commonwealth Court considered the contracts between Expedia and the hotels in reaching its holding. These contracts referred to Expedia's "right simply to facilitate or book reservations, not to rent rooms." They also explicitly stated that the hotel is the entity leasing the rooms. Moreover, the reservations made through Expedia were not necessarily guaranteed. Rather, the hotel only promised to make reasonable efforts to honor the reservations. In the case of overbooking, the hotel promised to relocate customers to comparable hotels. Therefore, the hotel, not Expedia, controlled access to the rooms and any amenities. Since Expedia did not control the premises, the Commonwealth Court agreed with the trial court and determined that Expedia did not fall under the definition of "operator."
The Commonwealth Court then considered the City's argument that a taxable transaction occurs when the consumer pays for and books a reservation through an OTC like Expedia. Under the Philadelphia Code, the term "transaction" is defined as the "activity involving the obtaining by a transient or patron of the use or occupancy of a hotel room."12 The booking of a reservation did not provide the consumer with use or occupancy of a hotel room. The booking only established the expectation that a room will be available to the consumer in the future. Moreover, hotels often permit cancellations and the use or occupancy of the hotel room may never occur. Therefore, the record supported the determination that the point of taxation was when the consumer registered at the hotel and actually obtained the hotel room.
Furthermore, the Philadelphia Code also provided that a transaction is the "activity... from which consideration emanates to the operator under an express or an implied contract."13 Consideration for a room rental ultimately "emanates to" the hotel or the "operator." Expedia merely passed through the payment. Under the Code's definitions, an operator receives consideration for, maintains custody of, and engages in a "transaction" for the room rental. Therefore, Expedia could not be deemed an "operator" and the tax applied to the amount paid directly by it to the hotel for the room rental.
Commentary
The Tennessee and Pennsylvania decisions are the latest in the growing volume of cases involving transactions with OTCs.14 While these two decisions concluded that hotel occupancy taxes did not apply to the total retail price charged for the room rentals by the OTCs, they acknowledged that the result could vary in other jurisdictions, depending on the language contained in each jurisdiction's laws.
Where decisions support the OTCs' position that tax only applies to the net rate, such jurisdictions may consider changes to their statutes that would explicitly subject to tax the total retail price charged by the OTCs, as a means to specifically address the business of OTCs. It is interesting to note that historically, the purpose of hotel occupancy taxes was to tax the temporary provision of a room to a guest. Attempts to tax the OTC on the margin between the true rental price of the room and the price charged by the OTC arguably go well beyond the original purpose of the tax. The OTC margin reflects a brokerage service function utilized in order to find a renter for a room that would otherwise go unoccupied, rather than amounts received for the pure act of renting a room historically covered by the hotel occupancy tax. While municipalities might find it appealing to tax that extra amount by folding such amount into their existing hotel occupancy tax statutes, the additional amount does not reflect payments purely made for the occupancy of a room. Therefore, trying to modify a statute to take this extra payment to the OTCs into account could be problematic.
The Multistate Tax Commission (MTC) is currently working on model legislation that would address this issue, either by requiring hotels to collect and remit the tax on the entire retail price, or by requiring the hotels and the OTCs to work together to ensure collection and remittance of the tax on the entire retail price.15 Meanwhile, OTCs are seeking Congressional action that would propose federal preemption from all state and local taxes imposed on hotel rooms when they are purchased through their Web sites.
Footnotes
1 Goodlettesville, Tennessee v. Priceline.com, Inc., U.S. District Court, Middle District of Tennessee, Nashville Division, No. 3:088cv800561, Feb. 21, 2012; Philadelphia v. Philadelphia Tax Review Board, Commonwealth Court of Pennsylvania, No. 216 C.D. 2011, Feb. 2, 2012. Note that the District Court's opinion spells the city's name as "Goodlettesville," but the city's name is officially spelled as "Goodlettsville." The official spelling is used in this SALT Alert.
2 The defendants were Priceline.com, Inc., Travelocity.com, L.P., Expedia, Inc. and Orbitz Worldwide Inc. as well as certain subsidiaries and corporate siblings of these entities.
3 Goodlettsville, Tennessee v. Priceline.com, Inc., 605 F. Supp. 2d 982 (M.D. Tenn. 2009).
4 Goodlettsville City Code § 58502 (emphasis added).
5 These more recent decisions were outside Tennessee and as such, served as persuasive (instead of controlling) authority for the Court.
6 Louisville/Jefferson Cnty. Metro Gov't v. Hotels.com, 590 F.3d 381 (6th Cir. 2009).
7 City of San Antonio v. Hotels.com, Civil No. SA8068CA83818OG (W.D. Tex. July 1, 2011).
8 City of Houston v. Hotels.com, L.P., No. 148108003498CV, Court of Appeals of Texas, Fourteenth District, Houston, Oct. 25, 2011.
9 Goodlettsville City Code § 58502.
10 Philadelphia Code § 1982402(1).
11 Philadelphia Code § 1982401.
12 Philadelphia Code § 1982401(14).
13 Id. (emphasis added).
14 The Kentucky Supreme Court also recently addressed the question of taxability of charges by OTCs. It denied the City of Bowling Green's motion for review of the Court of Appeals decision in favor of the OTC. See City of Bowling Green, Kentucky v. Hotels.com, L.P., 2011 –SC8 0003048D, Supreme Court of Kentucky, Order Denying Discretionary Review, Feb. 15, 2012.
15 The MTC's proposal, "Model Statutes for the Collection and Remittance of Lodging Taxes by Accommodations Intermediaries," has been reviewed by the MTC's Executive Committee, and a public hearing on the proposal will be held by the MTC in the next several weeks.
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