The Front Line of the E-Commerce Tax Battle: Update

Last month, the E-Commerce Times published a two-part series on the tax controversies being fought around the U.S. by online travel companies (OTCs) such as Expedia, Hotels.com, Orbitz, Pricelineand Travelocity.

Part 1 describes the e-commerce tax landscape and delves into the reasons all players are not equal.Part 2 explores some of the court cases surrounding this issue and the role of Congress in resolving it.

There have been three significant developments on this issue in recent weeks, and none are positive for the OTC industry.

The issue at the heart of these tax controversies is whether the OTCs should be collecting and remitting hotel room taxes on the full amount of the price they charge their customers. Currently, the OTCs collect state and local hotel room taxes only on the amount customers pay to the hotel for a room. State and local tax authorities are engaged in legal battles with OTCs all around the country in an effort to retrieve a significant amount of back taxes they believe are owed.

The three recent significant developments all involve Expedia, and they all represent defeats for the OTC industry in general. The fact that these three developments only involve Expedia should not be surprising, because Expedia has the largest share of the OTC business in many hotel markets. However, these developments will impact the entire OTC industry.

Georgia Supreme Court Decision

On June 15, the Georgia Supreme Court ruled that Expedia must pay hotel room taxes on the full amount it charges to its customers. However, the Court stated that this is a result of language in Expedia’s contract with the hotels, in which Expedia agreed to pay all applicable taxes.

The Court noted that liability for tax could be changed if Expedia changed this provision of its agreement with the hotels, requiring the hotels (and not Expedia) to collect hotel room tax on the full marked-up amount paid by the customer.

Such a modification would be difficult, because it would require that Expedia disclose to the hotel the amount being paid by the customer for each room night. It would also mean that the hotel would have to collect the entire amount for the room from the customer, and pay to Expedia its share of the customer payment. Such a change would result in a complete change in Expedia’s — and all of the other OTCs’ — business model.

This case is the first OTC tax controversy to be decided by the highest court in a state, and it now represents the law of the land in Georgia — at least until the Georgia legislature or the U.S. Congress passes a law to overturn this ruling.

This case was brought by a single taxing jurisdiction, the City of Columbus, against a single OTC (Expedia). This is not typical of many other cases going on in the country; in other cases, a single municipality has filed a class action case on behalf of all other municipalities within the state against all of the major OTCs. Perhaps it was the more streamlined nature of the “one tax authority v. one online travel company” posture of this case that led to it being the first to get to a state’s highest court.

San Francisco Hotel Room Tax Case

On June 19, a California trial court ruled that Expedia and Hotwire would have to prepay a disputed US$34 million hotel room tax assessment to the city of San Francisco before they could initiate a legal challenge to the assessment in the court system. This ruling is significant because it was issued by the same judge handling several other similar cases in California that involve all of the major players in the OTC industry.

San Francisco assessed its municipal hotel room tax against Expedia and Hotwire after an administrative hearing. The companies then sought to appeal this administrative ruling in the California judicial system, without first paying the tax. San Francisco filed a motion to dismiss, arguing that under California law, a disputed tax must be paid before a taxpayer can seek redress in the courts.

Although the law is clear in connection with state tax controversies, the question of whether a taxpayer is required to prepay a disputed tax before seeking redress in the courts is murky. The Superior Court ruled in favor of San Francisco, giving Expedia and Hotwire 45 days to pay the tax and amend their complaint. On July 9, the California Court of Appeals upheld this trial court ruling, requiring Expedia to pay the assessed tax in order to be able to appeal the assessment. On July 13, Expedia announced that it was making the required payment in order to continue the appeal.

This is problematic for several reasons. First, this is obviously a lot of money to have to put up to continue the appeal of this particular controversy. Second, there will likely be a similar result at the trial court level for Expedia for other similar cases that it is fighting against other California cities. Finally, since the same judge is hearing several other similar cases on hotel room taxes in Los Angeles, San Diego and Anaheim involving the other major OTCs, this ruling could have major repercussions for the entire industry.

New York City Ordinance

On June 29, New York City Approved a bill that will specifically require OTCs to remit the City’s hotel room tax on the marked-up amount received by an OTC. This clears up any ambiguity that the tax might not be applicable to OTCs.

However, there is a valid question as to whether the City has the authority to extend its hotel room tax to OTCs under the power given to the City by the state legislature to impose a tax on hotel operators. This question is likely to prompt future litigation. This new rule will be effective September 1. It is not clear whether this is an indication that New York City is giving up on claims for back taxes prior to this September 1 effective date.

State of Washington Class Action Case

On May 28, a trial court in the state of Washington ruled that Expedia is liable for $184 million in a consumer class action case.

The class action plaintiff alleged that the fees charged by Expedia to its customers to cover costs, including recovery of hotel room taxes, actually included additional mark-up, and therefore constituted a breach of its terms-of-service contract.

In this case, the plaintiff alleged that the service fee was charged not only to recover costs (including taxes) but also to increase profits. The plaintiff alleged that this was a breach of contract because Expedia’s terms of use explained that this fee was charged to recover costs.

Unfortunately, the plaintiff was able to produce an email from an Expedia executive explaining the service charge, saying, “As a company, this will add between $2-3 million in our net profit (the bottom line) next quarter.” The judge ruled that this statement showed that Expedia breached the terms of its contract by including profits in it service fee, and granted the plaintiffs motion for summary judgment on the breach of contract claim.

Expedia has filed a notice with the SEC disclosing this court ruling, stating that this judgment does not become final until a completion of the the trial on the remaining claims or until the Court amends its order making the summary judgment final, and saying that it will appeal this decision. This statement also advised that the “terms of service” at issue in this case were modified in December 2006.

Expedia will likely appeal this case, but in the meantime there is a risk of a double whammy: 1) It may have to refund the service fees to its customers collected during the period that the old terms of service were in effect if this Washington trial court decision is upheld on appeal; and 2) It might also have to pay back hotel room taxes to the many taxing jurisdictions around the country that it is current battling. To the extent that the other OTCs had a terms-of-service provision similar to Expedia’s prior to December 2006, they might also be subject to similar class action claims.

So, the OTCs have had an unfortunate run for a three-week period when it comes to the hotel room tax issue. However, Expedia and the other OTCs have revolutionized and invigorated the entire travel industry, and like all trailblazers, they are fighters. The OTC industry is certain to continue this fight in the courts, in the state legislatures and in Congress.