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Update on OTC/Government Tax Dispute: San Francisco Seeks Direct Collection of OTC Portion of Tax from Hotels David Colker September 22, 2011. Hotel Occupant Taxes.

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Update on OTC/Government Tax Dispute: San Francisco Seeks Direct Collection of OTC Portion of Tax from HotelsDavid ColkerSeptember 22, 2011

hotel occupant taxes
Hotel Occupant Taxes
  • Most local governments impose a hotel occupancy tax on hotel guests; the tax is typically collected and remitted by the hotel owner/operator.
  • Although the exact tax base may vary from state to state, it will generally include the hotel’s charge for the room.
  • These taxes are imposed by both states and cities. Although the thrust of these tax systems are very similar, there are many technical differences among the laws.
  • This lack of uniformity among the tax laws creates additional complexity when new business models are developed that may not have been contemplated at the time the laws were first enacted.

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commission model
Commission Model
  • One established model used to promote hotel room sales is a commission model, where travel agents may earn a commission for selling a hotel room at a price determined by the hotel.
  • In general, under this approach, the hotel books the room charge paid by the hotel guest as revenue subject to the hotel occupancy tax, and the hotel pays the travel agent a commission.

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otc merchant model
OTC Merchant Model
  • The OTCs have developed a merchant model under which OTCs sell the right to occupy hotel rooms to consumers.
    • The OTCs obtain rights from hotels to allow the OTC customers to occupy hotel rooms.
    • The OTCs agree to pay the hotels a “wholesale” rate for the occupancy rights.
    • The OTCs, in turn, charge their customers a marked up room charge, certain service fees and taxes.
    • The OTCs incur the risks of non-payment as they are the merchant of record with the customer.
  • The OTCs have developed several business models under this merchant of record approach, including an “opaque” model.
  • The OTCs also bundle other travel services with hotel rooms under this merchant of record model, such as airfare.

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tax dispute
Tax Dispute
  • The OTCs collect and remit to the hotels the occupancy tax on the “wholesale” rate charged by the hotel.
  • The OTCs generally do not collect and remit occupancy tax on any room mark up charge and/or any service fees.
  • Some local governments have claimed that both the mark up and service fees are taxable charges for hotel occupancy.
  • There have been over 30 court cases addressing aspects of this issue; many are still on going.
  • Both the OTCs and local governments have also sought a range of legislative “solutions” to this problem.

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overview of otc dispute
Overview of OTC Dispute
  • Although each local law may be unique, the dispute has focused on whether OTCs are responsible for tax collection and whether the mark up and/or service fee charged by the OTCs are within the tax base.
  • Court decisions across the country have been mixed, with many still on appeal. For example,
    • In three different California cases, the OTCs have won because they are not hotel operators. It is likely that all three cases will be appealed.
    • In a Texas case the OTCs lost because the court concluded that they exercised sufficient control over the relevant transactions so as to be responsible for collecting and remitting the tax on the total charge. This case will likely be appealed.

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new legislation
New Legislation
  • In a few jurisdictions new laws have been passed to clarify that such revenue is subject to tax.
    • For example, under a 2009 New York City law:
      • OTCs collect occupancy tax from customers on all rent (net hotel rent plus OTC mark up) as well as charges for any service or booking fees that are a condition of occupancy. The OTCs forward the net rent to the hotels along with the associated tax on the net rent, and the OTCs directly remit to the City the occupancy tax on the marked up rent and the associated taxable service and booking fees.
      • Hotels collect net rent from OTCs along with the occupancy tax on the net rent and then remit the tax to the City.
      • Thus, the City receives two streams of tax, one from the hotels on the net rent and one from the OTCs on the balance of the taxable customer payments.
      • This approach also facilitates audits, as each party has the relevant information relating to its tax remittance obligations.

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impact on hotel owners
Impact on Hotel Owners
  • Hotels have not generally been involved in tax disputes between governments and OTCs.
    • If governments win these cases and/or change their laws to extend the occupancy tax to the total amount paid to an OTC by a consumer for the room and associated service charges, then the cost of hotel occupancy will go up. The added cost is the amount collected and retained by OTCs multiplied by the occupancy tax rate.
    • Hotels could have challenging compliance burdens to the extent any new laws purport to require hotels to collect and remit the OTC portion of the tax, since they may lack sufficient information to do so.
    • Agreements between hotels and OTCs generally have cross indemnity provisions. Under such contractual arrangements, hotels generally seek indemnification from the OTCs for costs and taxes imposed on hotels relating to OTC activities.

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san francisco cases
San Francisco Cases
  • San Francisco previously sued the OTCs and collected tax, interest and penalties of approximately $50 million on the mark up and service fees; the OTCs sued for a refund and the case is in court.
  • San Francisco is the first government to also seek the OTC portion of the tax directly from the hotels; the City argues that the hotels are responsible for collecting and remitting tax on all amounts paid for “occupancy” to the OTCs by hotel guests. San Francisco also argues that the hotels and OTCs are jointly and severally liable for such tax obligations.
  • San Francisco has issued contingent assessments against 29 hotels (which it will seek to enforce if the OTCs win their refund case). These contingent hotel assessments apply to the period 2007 Q1 through 2008 Q3. The hotels have not yet paid these taxes.
  • Attempts by San Francisco to amend its ordinance to expressly tax the OTCs have failed.

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san francisco hotel litigation
San Francisco Hotel Litigation
  • San Francisco has also sued the 29 hotels seeking declaratory relief that the hotels are liable for the tax on the OTC mark up and service fee and that the City has the right to collect such taxes directly from the hotels.
  • San Francisco has also claimed in the litigation that the hotels have a fiduciary duty to collect and remit such taxes, and has claimed that the hotels have breached that duty.
  • San Francisco may continue to seek additional taxes from the hotels/OTCs during pendency of the current litigation, since the hotel assessments to date only extend to 2008 Q3.
  • To date, no other California city has brought similar claims against the hotels.

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hotel response to san francisco lawsuit
Hotel Response to San Francisco Lawsuit
  • In response to the City lawsuit, the hotels are seeking a court declaration that the hotels are not legally required to collect and remit tax on the OTC mark up and service fee, for reasons including that:
    • There is no hotel tax collection obligation on revenue collected and retained by the OTCs.
    • Hotels are only required under law to collect tax on amounts remitted to them by the OTCs.
    • Any hotel collection obligation in these circumstances would impose an unreasonable and illegal burden on the hotel as a tax collector.

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resolution of controversy
Resolution of Controversy
  • There is often a lag between the creation of a new business model and the development of appropriate and rational tax laws and rules that apply to them.
    • Many local governments are attempting to apply existing laws to a business model that may not have been contemplated when the laws were first enacted. In some cases, the courts have rejected those efforts.
    • The adoption of legislation that expands taxes or creates new taxes may be problematic for political reasons, but some governments will successfully pursue this solution. Under such approaches, an issue to consider is whether the OTC or hotel is responsible for collecting the tax on the OTC retained revenue.
    • The adoption of laws that create new tax exemptions may raise issues of equitable treatment for comparable commercial activities.
    • Due to the lack of uniformity of laws and the inherently local aspects of the issue, there may not be a timely, uniform resolution.

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summary
Summary
  • The OTC tax dispute is a national dispute likely to continue for many years; lack of uniformity of law adds to complexity.
  • Federal and state level legislative approaches have also been considered/adopted in part; such efforts are likely to continue.
  • Hotels may disfavor any legislative approaches that put the entire tax collection burden on them and/or adopt non-uniform exemptions with respect to e-commerce hotel marketing activities.
  • Best hotel protection is a strong indemnity clause in OTC contracts to ensure that OTCs are ultimately responsible for any tax on revenues collected and retained by them (and related defense costs).

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