Tide turning against online agencies in hotel-tax cases

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More than four years after the City of Los Angeles filed the first municipal hotel-tax lawsuit against 18 online travel agencies, the OTAs find themselves mired in litigation and bombarded with information requests, audits and assessments by municipalities, counties and states throughout the country.

At stake are potentially hundreds of millions of dollars in judgments and settlements.

In Anaheim, Calif., the defendants were socked with a $21.3 million tax judgment in February. In general, the cases have not been trending in the online giants’ favor.

So far, some 46 city and county taxing districts have filed lawsuits, many seeking class-action status. They allege that online sellers of hotel rooms, including Expedia, Travelocity, Orbitz, Priceline, their subsidiaries and other hotel intermediaries, are shortchanging local tax coffers when they collect hotel occupancy taxes on the retail rate but remit tax-recovery charges to the hotels based on the net rate.

While the trend has favored the plaintiffs, defendants can point to a few positive outcomes. Cases brought by Pitt County, N.C.; Findlay, Ohio; Columbus and Dayton, Ohio; Orange, Texas; and Louisville, Ky., were dismissed on the grounds that the OTAs were not subject to the taxes because they did not control room inventory.

The defendants point to a January appeals court ruling in the Pitt County case as especially significant because they say it was the first such decision to address the heart of the issue. The U.S. Court of Appeals for the Fourth Circuit ruled that the defendants were not subject to the tax because "they cannot be said to operate the hotels."

The OTAs also take heart in a March 18 U.S. District Court ruling in Newark that dismissed Lyndhurst, N.J.’s putative class-action complaint on behalf of the state’s municipalities. In that case, the judge ruled that only the state has the authority to enforce local hotel tax ordinances. The ruling did not touch on the merits of whether the OTAs actually owe any taxes.

Another 10 or so suits were dismissed without prejudice, meaning there was no ruling about tax liability. Instead, the plaintiffs generally were admonished that the proper recourse would have been to pursue audits, tax assessments and other administrative remedies before suing the defendants for unpaid taxes.

A costly contest

But one result of those rulings is that OTAs are feeling a lot of heat from pesky tax-department inquiries, audits and assessments.

In February, a hearing officer in Anaheim ruled that Expedia, Hotels.com, Orbitz, Priceline, Hotwire and Travelocity owed the city $21.3 million in transient occupancy taxes, penalties and interest for 2000 to 2008. The defendants were found to be liable for the 15% tax on the difference between the wholesale rate at which they had obtained the room inventory from the hotels and the retail rate, including service fees, that they had charged consumers.

Expedia, including Hotels.com and Hotwire, stated that its bill from the Anaheim finding was $17.7 million: $8.2 million in taxes and $9.5 million in penalties.

The zinger in these kinds of administrative assessments is that Anaheim, like many other cities and counties across the country, has what Expedia describes as a "pay to play" ordinance, which means defendants would have to pay the tax before being allowed to appeal any judgments.

However, a Superior Court judge in Orange County ruled on March 30 that the defendants could withhold payment while they appeal the $21.3 million judgment. In general, the plaintiffs accuse the OTAs of intentionally sticking it to local tax authorities.

"All along, this has been a very clear case of online travel companies cheating local governments by paying taxes only on the purchase price of discounted hotel rooms instead of on the retail price they charge consumers," plaintiffs’ attorney Patrick O’Connell of Baron & Budd said after the Anaheim ruling. "They tried to mislead consumers with unclear taxes and service fees, but the hearing officer saw right through them."

More than two dozen other administrative proceedings or assessments are under way, including cases in Indiana, Wisconsin, San Diego, San Francisco, Philadelphia and the counties of Miami-Dade and Broward in Florida. Orbitz indicated in a financial statement last month that so far it had been tagged for about $7 million in assessments.

Short of formal assessment proceedings, scores of other cities and counties as well as the state of Hawaii, entities that together represent hundreds of local tax authorities, have requested that the OTAs provide information for audit purposes or register to pay local occupancy taxes.

The OTAs generally do not register to pay taxes, arguing that they remit "tax recovery charges" to the hotels, which pay the tax.

In addition to acting on the judicial and administrative fronts, local governments in some cases have sought to rewrite their tax laws to hold the OTAs responsible for the full retail rate.

The City of Los Angeles, for example, adopted an ordinance several years ago designating online travel agencies as hotel operators. The Los Angeles suit, a potential class action, was stayed in 2007 until the city first exhausts administrative remedies to collect the tax. A status conference report was scheduled for May 15.

More recently in Florida, the state Senate’s Commerce Committee unanimously approved a bill that would make the OTAs responsible for tax on the retail rate. The bill, if passed, could go into effect July 1.

Fines, penalties, legal bills

In addition to all these government actions, the OTAs face a number of pending consumer lawsuits alleging deceptive business practices in the way they bundle service fees and taxes when offering hotel rooms to consumers.

With millions of customers who have booked hotel rooms on their websites and more than 7,000 taxing jurisdictions in the U.S., the consumer and municipal suits, many of which seek back taxes, interest, penalties and compensatory damages, strike at the heart of the OTAs’ lucrative and high-margin hotel business.

The OTAs are accruing massive legal bills as their lawyers scurry from courtroom to courtroom around the country, and some have set aside hefty reserves to help cover adverse assessments and judgments. Expedia alone set aside $20 million and $19 million in 2008 and 2007, respectively.

"Our reserve is based on our best estimate, and the ultimate resolution of these issues may be greater or less," Expedia stated.

Art Sackler, executive director of the Interactive Travel Services Association, a trade group representing the OTAs, said the suits have been a "tremendous waste of resources" for the OTAs and the municipalities: "We’d rather be promoting these destinations" than fighting them in court.

Sackler said that his association and the defendants were "confident" and "encouraged" at progress in the legal skirmishes, though he cautioned that it was difficult to speak of momentum because each case is different, with local tax laws varying widely.

Despite the assessments under way around the country and the Anaheim decision in particular, Sackler said he was confident none of the OTAs had yet paid any disputed occupancy tax.

Sackler characterized the Anaheim ruling as "discriminatory" and "prejudicial" because the city assessed the OTAs a tax liability but did not investigate tour operators, which also obtain inventory at a net rate and use the merchant model.

Sackler said he was not advocating that tax authorities now target wholesalers. But, he added: "In general, this business model has been around for a while. Why were we singled out?"

‘Seriously hammered’

One plaintiff’s attorney, who declined to be identified, said that "the defendants are getting seriously hammered" after four years of drafting a "mass of pleadings" and mounting "judicial roadblocks."

As evidence that the litigation is trending toward the plaintiffs, the attorney pointed to a 5-2 Georgia Supreme Court ruling on March 23 in the City of Atlanta case.

The court held that lower courts had erred in dismissing the case on the grounds that the city had not first exhausted administrative remedies before suing, and it remanded the case to the Fulton County court that initially heard it to decide the hotel-tax issue on its merits.

"In our view," the majority opinion stated, "the City cannot be required to exhaust an administrative process as a prerequisite to obtaining a determination that the ordinance prescribing that process even applies in the first place."

Henry Harteveldt, Forrester Research’s principal analyst for airlines and the travel industry, said the courts ultimately would decide which side would prevail in these disputes.

But he said adverse decisions like the Anaheim case "are not good news" for the OTAs, especially given the economic climate and the decision by Expedia, Travelocity and Priceline to forgo charging consumers booking fees on airline tickets.

With revenue down, "there is no question it would affect the companies’ margins" if adverse rulings become the norm, Harteveldt said. "It will affect what they do, and they would have to change their business plans."

However, Harteveldt added that the hospitality sector, which has waged pitched battles with the OTAs for years, would be happy, for competitive reasons, if the assessments and rulings go the municipalities’ way.

"The hotels are happy about this," he said. "They know this would reduce the margin available" to the OTAs.

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