Monday, December 19, 2016

Cal Supreme Court issues major decision on whether transient occupancy taxes to be collected by online travel companies (and cities everywhere should consider re-writing their TOT codes)

Last week, the California Supreme Court issued a tremendously important case for the land use world (30 attorneys are listed on the papers, and you can imagine the army of associates working behind the scenes).  The case, In re Transient Occupancy Tax Cases, No. S218400, 2016 WL 7187624 (Cal. Dec. 12, 2016), concerns the amount of transient occupancy tax (TOT) due when customers purchase a hotel room through online travel companies (OTCs).  The issue, which may seem arcane at first, is a very big deal because TOT tax is one of those "welcome stranger" taxes not paid by city residents that became popular with the fiscalization of land use that arose after property tax revolutions forced cities to rely on more esoteric forms of funding.  In San Diego, the TOT tax is 6%, more than sales taxes in many places.

In simple terms, the case is about whether TOT is owed on the "wholesale" price for which hotels contract with OTCs, or whether TOT is owed on the amount the customer pays (the "wholesale" price plus some OTC profit and fee increment--see below for the detailed description).  The legal issue was one of code interpretation.  The California Supreme Court held that under San Diego's existing TOT provision the tax is only due on the wholesale price.  That is the bad news for cities; the good news is that the Court based its decision only on code interpretation, which could easily be re-written to specifically address and include OTCs.    

This is an important case for cities across the country to read carefully.  Moreoever, cities will want to contemplate re-writing their TOT ordinances to explicitly reference OTCs.  This case--and its excellent briefing--provides a guide on how to do so for those local governments that need guidance.

Defendants here were a who's who of OTCs including:, L.P.;, Inc.; Travelweb LLC; Expedia, Inc.; Hotwire, Inc.; G.P., LLC;, LP;, LLC; Orbitz, LLC;;, LLC; Trip Network, Inc. (doing business as; and Internetwork Publishing Corp. (doing business as

Below are several useful excerpts.  Here is the Court describing the OTC business arrangement:

We first describe the nature of the transactions at issue. OTCs publish on their websites comparative information about airlines, hotels, and car rental companies, and allow consumers to book reservations with these travel and hospitality providers. OTCs may do business under any of several business models; involved here is the one known as the merchant model.2 Under the merchant model, OTCs contract with hotels to advertise and rent rooms to the general public. OTCs handle all financial transactions related to the hotel reservations and become the merchant of record as listed on the customer's credit card receipt, but do not themselves own, operate or manage hotels, maintain an inventory of rooms, or possess or obtain the right to occupy any rooms. The price the hotel charges the OTC for the room is the “wholesale” price; rate parity provisions3 in most master contracts between OTCs and hotels bar the OTC from selling a room for a rent lower than what the hotel quotes its customers directly. The OTC offers the rooms to the public at retail prices. Its charge to the customer includes a “tax recovery charge,” which represents the OTC's estimate of what the hotel will owe in transient occupancy tax based on the wholesale price of the room as charged by the hotel to the OTC. The OTC provides the customer with a receipt that lists the room rate and, on a separate line, an amount for taxes and service fees.4 Once the reservation has been made and paid for, the OTC provides customer service until the customer checks into the hotel. The hotel then bills the OTC for the wholesale price of the room plus the transient occupancy tax the hotel will have to pay based on the room's wholesale price. The OTC remits the charged amount to the hotel, which in turn remits the tax to San Diego; the OTC retains its markup and service fees.
Id. at *1.  Here is the Court applying this model to the San Diego ordinance:

San Diego contends the tax base for calculating the tax must be the full amount of the payment the customer is charged to obtain occupancy. In San Diego's view, the stated purpose of the tax—“It is the purpose and intent of the City Council that there shall be imposed a tax on Transients” (San Diego Mun. Code, § 35.0101, subd. (a))—reflects a legislative focus on the transaction between the OTC and the customer. The statutory definition of rent—“the total consideration charged to a Transient as shown on the guest receipt for the Occupancy of a room” (San Diego Mun. Code, § 35.0102)—in San Diego's view, shows the tax base was intended to be the total amount quoted to, charged to, and paid by the customer, not the lesser amount the hotel has agreed to accept as its share of the rental proceeds; indeed, a customer cannot obtain the privilege of occupancy by paying only the amount the hotel nets on OTC transactions nor anything less than the total amount quoted and charged to him or her. Moreover, San Diego observes, the tax is determined and collected at the same time the room is booked (id., § 35.0112, subd. (a))—the “taxable moment,” as San Diego calls it.

We agree with San Diego's argument in part. The ordinance imposes the tax on the amount “charged by the Operator” (San Diego Mun. Code, § 35.0103); it does not refer to amounts “received” or “collected” by the operator. To the extent a hotel determines the markup, such as by contractual rate parity provisions requiring the OTC to quote and charge the customer a rate not less than what the hotel is quoting on its own website, it effectively “charges” that amount, whether or not it ultimately receives or collects any portion of the markup, and that amount is therefore subject to the tax. Because, however, the ordinance imposes on “the Operator” alone the duty to remit the tax (San Diego Mun. Code, § 35.0114, subd. (a)), and subjects the operator alone to the assessment process when taxes are determined to be unpaid and owing (id., § 35.0117, subd. (a)), it does not appear to contemplate that the city treasurer may assess an intermediary such as an OTC for unpaid transient occupancy tax.
San Diego contends the entire amount paid by the customer, presumably including any portion of the markup within the exclusive control of the OTC above that set by the hotel, is subject to the tax because that amount is charged “for the privilege of Occupancy” within the meaning of the ordinance, and no lesser amount will gain that privilege for the customer. (San Diego Mun. Code, § 35.0103.) This contention, however, fails to acknowledge that the relevant ordinance identifies the taxable amount as the rent “charged by the Operator” (ibid.)—and the only such amount involved in online room rental transactions is, as we have seen, the wholesale room rate plus any portion of the markup set by the hotel pursuant to the contractual rate parity provisions or otherwise. Thus, it is the wholesale room rate plus the hotel-determined markup, exclusive of any discretionary markup set by the OTC, that is “charged by the Operator” and subject to the tax.

Id. at *3.



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