Originally published on Forbes.com.
Another round in the seemingly endless battle between on line travel companies and cities goes to the OTCs and the dollars are pretty substantial. Based on a 2015 ruling by the Cook County Circuit Chicago was expecting to collect $29,101,076.23 from Expedia and other OTCs. Now the Appellate Court Of Illinois – First Judicial District has given the city disappointing news. The lower court decision is overturned.
What Is It All About? Or Why I Root For The Cities
When you rent a room through an online travel company it is generally not the same as going through a travel agent. A travel agent, at least back in the day, was, well an agent. The hotel was the principal you were dealing with and they paid their agent (who you might have thought was your agent) a commission. And the hotel, depending on where it was, would charge you occupancy tax based on what the hotel charged you for the room. The hotel then remitted that amount to the tax authority. As a night auditor wrestling with an NCR mechanical monster originally designed for banks but modified for hotel use, I had the tax amounts for every possible room rate memorized.
The OTCs generally operate on a “merchant model”.They buy the room nights from the hotels and mark them up. That is where the taxes get funky. The OTC does not charge you tax on what you pay for the room. The OTC charges you a “tax recovery” amount. They then pay the operator occupancy tax based on the net rate the OTC is paying for the room.
What aggravates me about the system is that if the “tax recovery” amount is greater than the tax remitted to the operator, the OTC keeps the difference rather than refunding it. To be fair, I should be open to the possibility that the tax recovery amount is sometimes insufficient, but I’m a cynical bastard, and I’m thinking tax recovery is an additional profit center.
I don’t know why I find practices like “tax recovery” so annoying, but I do. A company should charge for its services enough to make a profit. It should not be increasing profits surreptitiously. I remember our managing partner coming back from one of the managing partner conclaves, where managing partners sit around and grouse about partners who actually work. The inspiration from that conclave was the “technology charge”. Rather than increase billing rates we would tack on a technology charge. That was to distinguish ourselves as an accounting firm, that, you know, used computers as opposed to all those other guys who just did all the math in their heads. It is the car rental companies that take the cake though. At check-in they try to terrify you into buying overpriced insurance and then they sell you a full tank of gas with instructions to come back empty. I rarely have the time to circle the airport a few times so I can coast in on fumes, which allows them to sell a gallon or two of my gas to the next renter.
That’s why I root for the cities in these cases.
The Big Picture
The Tax Foundation, which sometimes seems like the Anti-Tax Foundation, did a study of these cases last year. In their analysis, which I agree with to some extent, they seemed to conclude that the only people really winning these cases are the lawyers. Overall the OTCs have been winning, but since there is no overarching principle, but rather the wording of particular statutes, decision go both ways. TF is concerned:
The OTC litigation trend also raises concerns about administrative re-casting of old tax statutes to new situations not meant to be included, about the role of private contingency-fee lawyers in pursuing government tax claims, and whether ambiguous tax statutes should be resolved in favor of government or taxpayers.
I look at it a little differently. Online travel companies and services like Uber and Airbnb have the effect of lifting a significant part of essentially local services out of the nexus of local taxation. The goodwill and branding element of the price is abstracted away. Those companies do not fully share in paying for the local infrastructure that their services rely on.
Tax Foundation recommends federal legislation to create some sort of uniformity of practice in this area. That is probably a good idea, but I think that the uniform way to do it should be based on what the customer pays not on the net rate paid to the hotel.
And Chicago
The decision was pretty lawyerly, although it did have one amusing bit which caused me to hunt down a video clip.
To be sure, a defendant OTC may attempt to recoup overhead expenses related to providing information in setting the amounts that its customers ultimately must pay for that OTC’s facilitation and servicing of a reservation, just as a supermarket may incorporate the expense of advertising into the price of a banana. Nonetheless, a defendant OTC’s customers do not purchase the information itself, just as a supermarket’s customer does not purchase the jingle that brought him into the store to buy that banana.
All in though, the city was out of luck.
In reaching this determination, we reject the City’s contention that the tax base under the CHAT ordinance is the total amount the customer pays a defendant OTC. The City suggests that the facilitation and service fees must be in the nature of rent because they are collected at the same time as the net rate, i.e., the rent. Under that reasoning, however, the CHAT itself would be rent and therefore subject to the CHAT, a circuitous result indeed. While the City has also stated that the CHAT itself would not constitute rent under the City’s total-amount theory, the City has not explained why its reasoning should compel us to find that one component of the total constitutes rent but the other component does not. We decline to adopt the City’s unsupportable interpretation. (examining a tax “on the gross income derived from the sale of services or rental income resulting from all services activities that occur within the state” (emphasis added)). More importantly, the City’s interpretation would render the ordinance’s reference to “rental or leasing” superfluous.
We are similarly unmoved by the City’s observation that customers do not receive a precise breakdown of the four components that equal the total price, as the City has not explained why this imprecision would transforms facilitation and service fees into rent. Additionally, the City observes that the CHAT ordinance requires that tenants receive an invoice of the charge “upon which the hotel accommodations tax shall be stated, charged and shown separately.” Chicago Municipal Code § 3-24-050 (1990). Yet, this provision does not form the basis of the City’s complaint, and the City has developed no argument showing that this provision entitled it to additional tax revenue. We are not charged with considering whether customers are wise to pay defendants without a fully itemized receipt.
Other Coverage
Woltere Kluwer had a brief summary of the decision. John Bilyk had a piece titled Appeals court: Chicago can’t slap hotel tax on booking fees charged by Expedia, other travel sites. Hal Dadrick had something in the Chicago Tribune.
The court did not rule on the 2014 changes to the city tax code, saying it “applies to transactions entered into after the period in question here.”
The city’s next move — options could include accepting the ruling, appealing to the Illinois Supreme Court or working out a settlement with the online hotel reservation firms — was not clear. Law Department spokesman Bill McCaffrey declined to comment on the ruling, an uncharacteristic response from city officials who in the past have been quick to issue statements after courts issue rulings.
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