North Carolina Mulls Taxing Online Travel Agencies

Published February 14, 2010

In a scramble to find new sources of revenue, North Carolina is looking into taxing services provided by online travel agencies such as Expedia, Travelocity, and Priceline.

Among the alternatives being considered by the Revenue Law Study Committee—which is looking at a host of tax reform proposals—is the notion of taxing the service fee online travel companies charge for booking hotel rooms. Doing so, legislative researchers said at a January meeting, could raise between $6 million and $8 million a year in new revenues.

The state now applies the sales tax to hotel rentals, with 5.75 percent going to the General Assembly and the remaining 2 percent to 2.25 percent directed to local governments. Many cities and counties also charge separate hotel occupancy taxes, with rates ranging from 3 percent to 8 percent.

Trina Griffin, a member of the state General Assembly’s research division, suggested the current state and local sales taxes applied to hotel rentals could be extended to online travel agents’ service fees by considering the fees a “markup” on the price of hotel rooms.

Wholesale vs. Retail
“Online travel companies (OTCs) contract with hotels for the right to broker or facilitate room reservations at a discounted rate,” stated a slide in Griffin’s PowerPoint presentation to the committee. The OTC then sells the room to a customer at a slightly higher price, which reflects the discounted room rate, a service fee, and a tax recovery charge. The hotel gets the room rate, the OTC collects the service fee, and the taxes are forwarded to the government.

The tax is based on the discounted room rate, which she refers to as the “wholesale rate,” and not on the amount the customer actually pays, which Griffin calls the “retail” or “markup” rate. Some state officials think taxes should be assessed on the full price of the room rather than the discounted rate the hotels collect.

Andrew Weinstein, a spokesperson for the Interactive Travel Services Association, a trade group, says online travel agents should not be taxed as hotel operators because they do not operate hotels.

Fee, Not a Markup
Moreover, the difference between the amount the hotel receives and the amount the customer pays is a service fee, he said, not a markup on the price of the room.

The fee, ranging from 5 percent to 30 percent of the room rate, is a service charge for providing a Web site for consumers and facilitating the reservation, Weinstein said.

“It’s a creative interpretation of the law to twist service charges into part of the cost of the hotel room,” he said. “The occupancy tax was intended to be interpreted narrowly to apply only to the cost of the room.”

Room service and parking services, for example, are not covered by the occupancy tax, he said.

Travel Industry Victories
Weinstein suggested any proposal at the state or local level to tax online travel agents separately would have tough sledding in court. Although several cities and counties across the country have sued online travel companies to collect the tax, most have lost their cases. And when local governments have won, the decisions have been appealed.

Six of the seven federal courts that have ruled on the issue have sided with travel companies, including the 4th U.S. Circuit Court of Appeals, which last year overturned Pitt County’s attempt to impose its local occupancy tax on online travel agents.

“The facts are on our side, the law is on our side and, most importantly, common sense is on our side,” Weinstein said. “If you’re not a hotel, you shouldn’t pay hotel taxes.”

Seeking Retroactive Windfall
Griffin said the state will most likely wait for pending court cases to be decided before acting. If federal appellate courts cannot agree on the legality of the tax, the issue could reach the U.S. Supreme Court, she said.

North Carolina would have another option if the occupancy tax cannot be applied to online travel agencies, Griffin said. Lawmakers could enact a new tax that would apply specifically to the service fee.

Creating a new tax would not generate as much money as applying an old one, since the state could not collect the new tax retroactively, as cities that have extended hotel taxes to online travel agencies have attempted to do.

More Cost, Complexity
Weinstein said although enacting a standalone service tax would be more honest than applying the occupancy tax, it would still backfire.

“A tax that hit the tourism industry would have a counterproductive impact,” he said. While cities and states might “collect more money temporarily, they’d lose revenue in the long run by discouraging tourism.”

Weinstein also noted the complexity online travel agents would face if forced to collect separate taxes charged at the state and local level. There are 7,000 taxing authorities around the country. If every city and county had different policies, he said, it would become impossible for travel companies to keep track of how much tax should be collected for each reservation. Double or even triple taxation might occur if cities, counties, and states imposed separate taxes.

“The possibilities become staggeringly complicated,” Weinstein said. “To have that many taxing authorities would drive online travel agencies out of business.”

Sara Burrows ([email protected]) is an associate editor of Carolina Journal, where this article first appeared. Used with permission.