Contingency fees driving hotel tax cases

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ElizabethBHERRINGTIONContrary to a May 4 Travel Weekly report ["Tide turning against online agencies in hotel-tax cases"], the tide is not turning against online travel companies in occupancy-tax cases. Of the handful of cases decided on the merits, no court has ruled against Orbitz. Indeed, four federal courts have found that the online companies are not subject to the hotel occupancy taxes. 

The article also neglected to mention that these cases are being driven by lawyers working on contingency fees, seeking to line their pockets at the expense of the tourism industry, rather than truly benefit the taxing authorities they represent. In reality, these cases are anti-travel, anti-consumer and ultimately bad for the tourism industry.

The online companies are winning

In cases brought by Pitt County, N.C.; Findlay, Ohio; Columbus and Dayton, Ohio; Orange, Texas; and Louisville, Ky., federal courts have ruled that the applicable occupancy tax ordinances did not apply to the online companies' compensation for their services. The Pitt County, N.C., decision was appealed to the U.S. Court of Appeals for the Fourth Circuit, which agreed with the trial court's ruling.

In addition to the court cases, a few cities and counties have requested information from the online companies to perform audits, none of which has resulted in their having to pay any local occupancy taxes.

The article notes that a hearing officer hired by Anaheim, Calif., ruled against the online companies in an administrative audit process. However, that ruling is now being appealed in the courts, the first step in a long process. A California Superior Court recently ruled that the online companies need not pay the tax while appealing.

A novel theory

These cases involve what is known as the "merchant model." For more than 30 years, intermediaries such as travel agents, tour operators and travel consolidators have facilitated hotel reservations using a merchant model in which the intermediary is the merchant of record on the hotel's reservation transaction.

Under a typical merchant model transaction, a portion of the total price paid by the consumer goes to the hotel, which sets the room rate, rents the room and is liable for local taxes. A small portion goes to the online company as compensation.

As these local laws are written (the vast majority were enacted decades before the Web existed), hotel occupancy taxes are to be calculated and paid by hotels' owners or operators. Since online agencies clearly do not own or operate hotels, occupancy taxes were never intended to be applied to them.

As e-business grew, more and more customers used online companies for travel. By 2004, an organized group of contingency-fee lawyers contrived a novel idea: Create the illusion that online companies were somehow avoiding paying taxes to communities around the country, selectively targeting online companies but not traditional travel agents or the airlines, which use the same model in booking hotels.

To sell their idea, plaintiffs' lawyers made a compelling offer to the cities and counties. If the case fails, the municipality loses nothing. If the case is successful, the lawyers take up to 30% of what is collected.

Contingency fee arrangements in tax cases set a troubling precedent in which local governments delegate the prosecution of their tax laws to outside lawyers who have a direct financial interest in the outcome of these cases and thus in finding a large tax liability. Because this delegation of government authority undermines the integrity of the process, the online companies have challenged the use of contingency-fee lawyers in these cases. The matter is pending in the California Court of Appeals.

Online companies provide customers with the ability to search a wide range of hotels at reduced rates and to compare the rates and amenities of multiple hotels. For hotels, they help put heads in beds that would otherwise be empty. And for governments, they help generate tax revenue beyond the hotel occupancy tax that these communities would not have otherwise seen.

Unfortunately, actions by plaintiffs' lawyers have recently led some online companies to decide independently not to do business in certain jurisdictions.

Though the law in these cases is on the online companies' side, they are being forced to spend millions of dollars a year on legal costs. This money would be much better spent promoting destinations and providing enhanced services that in turn would help drive additional tourism.

Elizabeth B. Herrington, a partner at McDermott Will & Emery LLP in Chicago, represents Orbitz in occupancy tax litigation.

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