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Online Travel Agencies' Collection of Fees and Taxes
 Scrutinized by Taxing Authorities with a
 Substantial Hotel Base


By Kathy Bergen, Chicago Tribune
Knight Ridder/Tribune Business News 

Nov. 6, 2003 - Are online travel agencies such as Expedia and shorting state and local governments on hotel-room taxes? 

A short seller, or stock-market player who is betting on a share-price downturn for companies that run online travel agencies, has been raising that question with taxing authorities and in the media. 

And slowly but surely, his query is gaining attention, particularly because post-9/11 travel jitters, the lingering economic slump and heavy discounting on the Internet already have cut into occupancy tax revenue streams. 

The query, which includes sophisticated financial presentations, does not disclose the author's identity. 

"We've been getting information anonymously, which I think is bizarre," said Martha Haynie, comptroller of Orange County, Fla. "I'm sure it's probably being sent by someone who thinks he can make some money off it ... but I'm interested because I want to make sure I'm not missing a taxable opportunity." 

Prior to 9/11, her tourism-heavy county--home to Walt Disney World, SeaWorld Adventure Park, Universal Studios Florida and Dolly Parton's Dixie Stampede--was raking in $108 million a year in taxes on hotel stays. 

This year, receipts are expected to be 15 percent less, or $92 million, about the same as last year. 

"You can see why this has got our attention," said Haynie, whose county relies solely on this revenue stream to pay off bonds on its newly expanded convention center. 

Haynie's proactive stance on the issue is one worth adopting, say some observers, particularly because online hotel booking is growing at a very rapid clip, with leisure bookings alone more than tripling since 2001, to 8.7 billion this year, according to Forrester Research Inc. 

"This is an area of potential revenue loss that needs to be closely examined by any [taxing authority] that has a substantial hotel base," said Richard Pomp, an assistant professor specializing in state taxation at the University of Connecticut Law School. 

The unidentified short seller stands to gain if investors become convinced that publicly held online travel agencies face a significant tax liability that could erode profits, an assertion the companies dispute. 

Generally speaking, "corporations are furious about the activities" of short sellers who spread negative information, said David S. Ruder, a former chairman of the Securities and Exchange Commission who is a professor at the Northwestern University School of Law. 

But the SEC intervenes only when it appears the short sellers are deliberately spreading false information, he said. 

In fact, some short sellers have proven themselves to be accurate troubleshooters. Among the most notable has been James Chanos, who gained a name for himself by being one of the first to flag problems at Enron. 

The online travel agency situation is a bit more unusual, however, in that the critic has chosen to remain underground. 

"I don't know of any case where a failure to identify oneself has been found to be improper conduct," Ruder said, "though it raises concerns about whether the information is reliable--it's a credibility issue." 

Charles J. Landy, a Washington, D.C., securities attorney who used to work for the SEC's enforcement division, represents the anonymous individual or individuals who are raising the taxation issue. 

"My client has an interest in preserving confidentiality... but there is nothing nefarious here," he said. 

Landy said all the information packets he sent to taxing authorities included a letter disclosing his client's short position in some companies that operate online travel agencies. He declined to discuss whether his client included such a letter in materials he sent on his own. Materials delivered to the Chicago Tribune did not include that information. 

And Landy declined to say if his client continues to hold short positions in companies whose businesses include online travel agencies. 

In any case, Landy said, his client is merely raising an issue. 

"Taxing authorities ultimately have to make analyses about whether their tax applies and whether they should proceed against these companies," he said. "And I am highly confident these companies have positions at law and in policy as to why they should not have to pay the tax. There is no sneak attack here. This isn't Pearl Harbor." 

The tax issue is a little tricky to grasp, and it does not apply to all online hotel booking transactions. 

If a customer books a hotel room through a hotel-company site, he or she pays tax on the entire bill. No issue there. 

And if a customer books through an online travel agency, but does not pay the bill until checkout, he or she again pays tax on the entire bill. No issue there either. 

But if a customer books through an online travel agency, and pays the agency in advance, then a tax issue emerges. 

What's at work is something called the "merchant model," an increasingly popular business model whereby an online travel agency acquires hotel rooms at wholesale rates, then marks them up, often by 15 to 30 percent, before selling them to the public. 

On top of the retail price, the customer often pays another charge, for fees and taxes, in an amount that typically mirrors or exceeds the amount of state and local taxes that would be due on the full retail price, Landy's client notes in his study. 

But the online travel agencies generally only pay taxes on the wholesale price charged by the hotel. 

A number of taxing authorities are starting to question this practice, though it appears none have gone to court yet. Online travel companies say they are operating within the law, though at least one has set aside a reserve in case the courts eventually decide otherwise. 

The bottom line is that occupancy-tax collections could be down about $5 per room-night in instances when the room is purchased in advance from the online travel agency, Landy's client estimates. 

Whether this figure is on target is subject to some debate, but in any case, a discrepancy of several dollars per room-night adds up rapidly in markets where millions of room-nights are sold each year. 

In the Chicago area, for instance, 21 million room-nights were sold last year, according to Smith Travel Research. And about 15 percent of hotel rooms are booked online now, according to Forrester Research Inc. 

Nailing down how much money may be going uncollected in any given market is difficult, however. Taxing bodies would have to ascertain how many rooms were sold online, how many of those were sold under the merchant model, and what the differential was between the retail and wholesale prices paid. 

Haynie said she plans to seek meetings with hotels in her county to see what sort of detailed information might be available. 

Among the other taxing authorities looking into the issue nationwide are the City of Houston, the City and County of San Francisco, the State of New York and the State of Florida. 

In researching the issue, some jurisdictions are trying to figure out what contractual arrangements exist between the online travel agencies and the hotels, and then how their own tax laws would apply, if at all. 

Ultimately, taxing authorities will have to determine if their statutes apply taxes to the wholesale price received by the hotel, or the retail price paid by the customer, said Pomp, of the University of Connecticut Law School. 

"And it might be one way in one municipality and one way in another," he said, depending on how statutes are worded. 

In this region, the issue has not hit the radar screens of local taxing authorities in any significant way. But after learning of it, some were skeptical that anything was amiss with tax collections, which total more than 14 percent in Chicago, with slices of that going to the state, the city and two other government agencies. 

Illinois Department of Revenue auditors will look into the issue, said spokesman Mike Klemans. 

But the department's initial reaction was that the state tax rate applies to gross receipts of a hotel, not to service fees of travel agents, he said. 

And Bea Reyna-Hickey, director of revenue for the City of Chicago, said if courts eventually find any misrepresentation occurred in online travel agencies' collection of "fees and taxes," the refunds likely would go to taxpayers, rather than taxing authorities. 

Barry Diller's InterActiveCorp, whose stable of businesses includes Expedia and and will soon include, is the 800-pound gorilla in the online hotel booking business, accounting for 60 percent of all transactions on non-hotel sites, according to PhoCusWright Inc. 

InterActiveCorp has addressed the tax issue directly in some recent SEC filings and public statements. 

"The company does not collect or remit taxes on the portion of the customer payment it retains," the company stated in a recent filing, adding that it believes this practice is supported by sound arguments. 

"A limited number of jurisdictions have questioned the company's practice in this regard," the filing noted. 

The company contends its exposure is limited, and it has established a reserve of less than $10 million for any potential payments that may result from legal judgments or settlements. 

In a recent statement, the company noted that only a limited number of jurisdictions have raised the issue, that tax provisions vary among jurisdictions and that many jurisdictions limit the obligation to collect occupancy taxes to hotel operators, a category that would not include online travel-booking businesses. 

"We do not believe [this issue] will have a material impact on our past or future financial results," the company said. 

Chicago-based Orbitz, the online travel agency owned by five airlines, said the tax issue does not apply to online agencies. 

"We collect occupancy taxes from customers, based on what the hotels instruct us to collect... The hotel operators are responsible for remitting the appropriate taxes to authorities," said Terri Shank, a company spokeswoman. 

This kind of talk is giving the hotel industry the jitters. 

If the tax man comes knocking on hotels' doors, it will create a whole new set of issues for the industry, said John Gay, vice president of governmental affairs for the American Hotel & Lodging Association. 

For example, it would be difficult for a hotel to know how much was paid for a room at retail. 

But Gay doesn't expect the pressure to ease anytime soon. 

"There are widespread budget shortfalls in state and local governments, so there is pressure to find additional revenue," he said. "Everybody is looking for money, it seems." 

-----To see more of the Chicago Tribune, or to subscribe to the newspaper, go to 

(c) 2003, Chicago Tribune. Distributed by Knight Ridder/Tribune Business News. IACIZ, ROOM, 


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