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Online travel companies subject to city taxes, court rules

Symbol of law and justice in the empty courtroom, law and justice concept.

Symbol of law and justice in the empty courtroom, law and justice concept.

Online travel companies like Orbitz, Travelocity and Priceline have to pay city sales taxes on the portion of the reservation dollars that they keep, the Arizona Supreme Court ruled Monday.

In a split decision, the justices concluded that these companies effectively are engaged in the business of operating a hotel. And, given that the Model Cities Tax Code used by the 11 cities involved in the lawsuit taxes hotel operations, that makes any money kept by these travel “brokers” subject to the levy.

That conclusion drew derision from Justice Ann Scott Timmer.

Writing for herself and Chief Justice Robert Brutinel, she suggested that the position of the cities – and the majority ruling – was stretching the concept of what it means to “operate” a hotel.

“Online travel companies neither put hotels into a functional or operative state nor keep them in that state,” she wrote. “Online travel companies do not own hotels, oversee hotel operations, or let hotel rooms.”

But Justice John Lopez, writing for the majority, saw it different, saying the services provided by these hotel brokers are “central” to keeping the hotels in operation.

The victory for the cities, however, was not absolute: The justices said they cannot collect taxes that were owed before 2013.

Central to the issue is how these online travel companies operate – and how the tax is levied.

Consider a $100-a-night room in a city with a 10 percent hotel tax, sold through a broker who has an arrangement to keep 20 percent.

The broker sells the room to the customer for $100, plus the 10 percent tax and any service fees. Then, after the stay, the hotel bills the broker for $80 plus the 10 percent tax of $8.

That $8 is sent by the hotel to the city; the broker keeps the remaining $22, remitting none of that to the cities in which the hotels were located.

In 2014 the cities issued assessments for the unpaid assessments going back as far as 2001.

Lopez said the tax on hotels themselves, which is not at issue, is based on a definition that they furnish lodging to transients. And he said that includes activities that are “essential to furnishing lodging.”

That, he wrote, is clearly the case here.

“From the time a customer makes a credit card payment until the customer physically checks into the hotel, the OTCs facilitate all aspects of the transaction and receive compensation in the form of service fees and markups on the room rental rates for providing their services,” Lopez said.

“It would be illogical to conclude that the OTCs – which advertise available rooms, solicit potential customers, collect customers’ information, process payments, confirm reservations, provide customer service, and facilitate reservation modifications and cancellations – are not actively engaged in ‘the business of operating a hotel,’ ‘ he explained. “Indeed, all these services provided by the OTCs are central to keeping a hotel functional and in operation.”

Timmer, in her dissent, pointed out that these companies perform only a limited number of the operations that actually keep a hotel in business.

“They do not possess, run, control, manage, or direct the function of a hotel or rental agency,” she wrote. “And hotels, which take reservations outside the OTC-process, do not depend on OTCs to operate their business.”

She acknowledged that there is no question that the travel companies facilitate hotel operations, like confirming reservation requests, processing payments and, if necessary, handling cancellations.

“But these functions – even though important to hotels – do not transform OTCs into operators of hotels,” Timmer said. She said that would lead to illogical conclusions like saying that a company that contracts with a hotel to provide cleaning services and hires workers then also becomes a hotel.

Lopez sniffed at that comparison, saying those services are “plainly distinguishable from those performed by the OTCs and are not necessarily central to the primary function of a hotel to furnish lodging.”

More to the point, he said these travel companies operate as brokers for the hotel’s central function.

And Lopez said taxes would still be due if hotels divided up all the aspects of its operations, charging separately for reservation services, advertising and customer support.

Monday’s ruling most immediately affects Apache Junction, Chandler, Flagstaff, Glendale, Mesa, Nogales, Phoenix, Prescott, Scottsdale, Tempe and Tucson, which are the cities currently trying to assess the levy. But it could open the door to other communities seeking to extend their own taxes to the travel companies.

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