Expedia, Hotwire, and Priceline cost the city millions in taxes

In December 2016, the California Supreme Court ended a 13-year legal fight waged by San Diego to collect tens of millions of dollars in hotel occupancy taxes from online travel companies such as Expedia, Hotwire, and Priceline.

In the ruling, the state’s highest court found that San Diego’s municipal code requires hotel operators, not online travel firms, to collect transit occupancy taxes from guests, meaning the online travel companies are only responsible to charge hotel taxes on the wholesale amount they purchase the rooms for and not the amount that they charge for the rooms.

Gaps in municipal codes exist due to the fact that most transient occupancy statutes were written decades before the creation of the internet, well before online travel companies existed. By failing to update the codes, municipalities such as San Diego have had to play catch-up with newly emerging technologies. In doing so, online travel firms were placed into a “merchant” role — in other words, selling discounted hotel rooms instead of acting as agents for those hotels. Online travel firms and the hotels reached an agreement that the online companies were only responsible to pay taxes on the discounted amount they purchased the hotel rooms for and not the retail amount.

Under the current set-up, San Diego and other cities throughout the country haven’t collected millions in tax revenues they would have received had visitors purchased rooms directly from hotels. In 2010, San Diego staffers estimated that approximately $3 million was lost per year, an estimate that has likely increased in recent years to reflect higher room rates and the rising popularity of online travel firms. In an effort to recoup what San Diego’s financial staff estimated to be $21 million in back-taxes from the years 2000 to 2008, San Diego’s elected officials opted to fight the arrangement in court.

But as deputy city attorneys worked in conjunction with outside legal counsel to fight the online travel companies in court, Katheryn Rhodes, a local civil engineer and advocate for the homeless, prodded the city to alter course by changing the city’s municipal code to include online travel firms. Doing so, Rhodes suggested, would have ended a long legal fight and also compelled online travel companies to pay the full share of hotel occupancy taxes. Rhodes says that the extra hotel tax revenues, were the new law written correctly, could be directed to the city’s general fund to help pay for services and important city issues such as solving, or at least addressing, homelessness in San Diego.

Beginning in 2014, Rhodes has been asking San Diego’s city councilmembers to place a measure on the ballot, a required step when dealing with any tax measure. But the council stayed the course.

In 2016, she once again asked the council to place a measure on the ballot in order to address the long-running dispute over online travel companies and hotel occupancy taxes. Council again chose to ignore her proposal.

“Free cash is being lost,” says Rhodes. “This is very low-hanging fruit, and San Diego is losing general fund revenues that could solve our homeless problem due to misinformation from outside attorneys looking for large payouts, lack of financial analysis from city staff, and failed leadership from San Diego’s elected officials.”

Amending the code to include online travel firms is not a new idea. However, only one city in San Diego County has taken the initiative to the voters. In 2012, the City of Santee approved an amendment to the Transient Occupancy Tax statute, which designates online travel companies as a hotel operator.

“Our [transient occupancy tax] ordinance applies the tax to the full amount of rent charged to the transient, and defines rent as the total consideration charged to the transient, including service charges and online booking fees without any deduction there from whatsoever,” says Santee finance director Tim McDermott. “The ordinance also defines the operator to specifically include [online travel companies], thus requiring either the [online travel firm] or the proprietor of the hotel to remit [the hotel tax] based on the full amount that the guest pays and not the discounted amount.”

Larger cities throughout the country have followed Santee’s lead. In 2014, 76 percent of voters in Palo Alto approved increasing their transient occupancy tax and to include “online brokers” as registered agents required to pay the full share of taxes.

In 2015, the City of Chicago amended their hotel-tax ordinance to include online travel firms. The decision to do so occurred two years after a Cook County judge awarded the city $29 million in back-taxes from the online travel companies, a decision that strayed from courts in other parts of the country.

Namara Mercer, executive director for the San Diego Hotel Motel Association, says her group is ready and willing to work with the city on any future amendment or change to the municipal code to include online travel firms. She says a proposal is working its way through city departments. A city spokesperson did not respond to a request for comment.

“This isn’t a new issue,” Mercer said during a March 10 phone interview. “Cities throughout California, San Diego included, have failed to keep up with the new technology and trends, whether that’s home-sharing websites [such as Airbnb] or online travel agencies. The city is aware that we want to work with them to get this done or, at the least, be part of the discussion.“

However some experts say amending the city’s hotel tax ordinance could be more difficult than Rhodes and others think.

Joseph Henchman, vice president of the Washington DC-based Tax Foundation and former Oceanside resident, believes amending the ordinance could possibly invite expensive legal challenges and that applying decades-old ordinances to include new technology doesn’t work. Also, passing such an ordinance would require a two-thirds voter approval.

“The cities argue that these statutes are elastic enough or forward-thinking enough to apply to online travel companies even though they wouldn’t exist for several decades, when current statutes were writen and weren’t remotely contemplated by the drafters or included in the text.”

Henchman likens it to trying to tax secretaries or travel agents who used to book travel for their bosses. Furthermore, targeting one specific group in an attempt to generate additional revenues is troublesome.

“Explicitly passing a tax on facilitating travel transactions to their [city] will make it sound like they don’t want people visiting. It’s one thing to make a big faceless out-of-state company like Expedia pay a tax, but the law would have to be written more broadly than just them or else it would violate constitutional restrictions on only taxing out-of-state companies but not taxing in-state companies.”

Rhodes plans to continue her efforts. “Hopefully someone in a leadership position will finally act so that no more revenues are lost to out-of-state online travel agencies and instead can go to helping San Diego residents.”