United States: District Of Columbia Holds OTCs Are Liable For Sales Tax

The Superior Court of the District of Columbia recently held that online travel companies (OTCs) owed sales tax on the retail rate of hotel rooms charged to customers via their Web sites.¹ However, the Court did not find the OTCs liable for negligence or failure to file penalties. In finding against the OTCs, the Court rejected each of the OTCs' affirmative defenses. The Court also addressed a motion for summary judgment filed by two defendants who maintained that they were not OTCs, but merely parent companies.

Online Travel Companies

OTCs book hotel rooms and make other travel arrangements for customers over the Internet. OTCs first enter into contracts with individual hotels and negotiate a discounted rate for each hotel room, commonly termed the wholesale rate. OTCs then offer reservations of the rooms to the public at a higher rate that includes the amount paid to the hotel operator, plus taxes and service fees. After a customer pays the total amount to an OTC and completes his or her stay at the hotel, the OTC pays the wholesale rate and the taxes based on the wholesale rate to the hotel. The hotel then remits the taxes to the appropriate taxing authorities.

Background

On March 22, 2011, the District of Columbia filed a lawsuit against a group of OTCs for failure to identify and remit taxes on the online sales of hotel rooms for occupancy. The OTCs filed a Motion to Dismiss, which was denied on October 12, 2011. In 2012, the parties filed four motions for full or partial summary judgment. The main issue before the Court was whether the OTCs were required to collect the District's gross sales tax on the retail charge of the hotel rooms.

Pre-April 2011 Statute

The Court first addressed the statutory scheme as it was prior to the amendments that were made beginning in April 2011.² The Court began its analysis by pronouncing the rules of statutory interpretation. First, the words of a statute must be read "in light of the statute taken as a whole." When the words of a statute are ambiguous, the Court must look to the legislative history and other tools of statutory construction.

Applying these rules to the version of the gross sales tax statute that was in effect prior to April 2011, the Court found that the definition of a "retail sale" is ambiguous. A "retail sale" was defined as "[t]he sale or charge for any room or rooms, lodgings, or accommodations furnished to transients by any hotel ... or any other place in which rooms ... are regularly furnished to transients for a consideration."³ Due to the ambiguity, the Court scrutinized other statutory provisions as well as legislative history to determine whether the OTCs were obligated to collect tax on the retail rate of the hotel rooms. The tax was imposed upon all vendors for the "privilege of selling certain selected services" and the tax applied to the "gross receipts from the sale of or charges for" hotel rooms or accommodations furnished to a transient by a hotel or any other place in which accommodations are furnished.⁴ The Court determined that the tax applied to the "sale or charge" for the service, and not the provision of the service itself.

In addition, the Court stated that the statute defined a "purchaser" as the end-user or person who ultimately received the service in exchange for consideration, and that the vendor is the entity on the "other side of a taxable sales transaction." Thus, the OTC was a vendor who offered a room, at a specified price, to the transient purchaser. The Court went further to explain that the application of the tax on gross receipts meant that the total amount of the sales price, without a deduction for any services that are a part of the sale, is subject to tax. Therefore, the OTCs' services fell within the services taxable under the pre-April 2011 statute and tax was owed on the full retail charge to purchasers.

Conducting Business in District of Columbia

In addition to arguing that their services were not taxable under the statute, the OTCs contended that they were not subject to the sales tax because they were not providing a taxable sale that occurred within the District. The Court found that the gross sales tax applies broadly to "all vendors" and that there were no explicit restrictions on the location of a vendor that falls under the tax. The Court also gave deference to the interpretation of "doing business" by the District's Office of Taxation and Revenue (DC OTR). According to the DC OTR, a retailer engages in business in the District when it participates in "any activity in connection with the selling, delivering, or furnishing in the District" of any property or services sold at retail.⁵ Since the OTCs' activities were directly associated with the selling or charging of hotel rooms located in the District, and the OTCs engaged in contracts with hotels in the District, the Court held that the OTCs engaged in business in the District under the pre-April 2011 gross sales tax.

April 2011 Amendments

On April 8, 2011, the District's gross sales tax law was amended as an attempt to remove any alleged ambiguities in the plain meaning of the statute. Significantly, the term "room remarketer" was introduced into the sales tax law for the first time, and was defined as "any person, other than the retailer, having any right, access, ability, or authority, through an Internet transaction or any other means, whatsoever, to offer, reserve, book, arrange for, remarket, distribute, broker, resell, or facilitate the transfer of rooms the occupancy of which is subject to tax ..."⁶ The term "room remarketer" was intended to encompass OTCs. In addition, the definition of a "retail sale" was modified to include the term "room remarketer," making it explicit that the OTCs' services are retail sales. However, the tax was to be determined "based on the net sale or net charges" received by the room remarketer and the Court found that the terms "net sale" and "net charges" were ambiguous due to an inconsistency in the statute. As such, the Court again turned to other evidence of legislative intent. The preamble to the legislation and the fiscal impact statement in a committee report indicated that the tax would apply to the total amount charged to the transient. Hence, the April 2011 amendments did not change the result that the OTCs' full charge to a customer was subject to tax. The Court rejected the OTCs' argument that a change in the law implied that the earlier version of the law was ambiguous.

Post-April 2011 Amendments

In June 2011, the legislature again made amendments to the statute, removing the inconsistent use of the term "net charges." The legislature also included two slightly different definitions of the term "room remarketer." One of the definitions states that a room remarketer has some sort of "right, access, ability or authority to determine the sale or charge for the rooms, lodgings, or accommodations."⁷ The OTCs argued that they were not room remarketers under this definition. The Court rejected that argument because it found that the OTCs decide upon the ultimate retail rate charged to a transient and upon the classification of charges that make up the total retail rate. Thus, having the ability to determine the sale or charge for the rooms, the OTCs constituted room remarketers under both definitions in the statute. In September, yet another amendment eliminated what was deemed to be an unnecessary set of definitions of certain terms. The Court held that these post-April 2011 amendments did not change the outcome for the OTCs.

OTCs' Affirmative Defenses

The Court rejected several affirmative defenses asserted by the OTCs, including several with constitutional implications. The Court held that the dormant Commerce Clause of the U.S. Constitution was not violated, due to the fact that all prongs of the applicable test were met.⁸ The OTCs also failed to prove that their equal protection rights were violated, as they failed to meet their burden of showing that the District's selective prosecution was improperly motivated.⁹ Finally, the imposition of the gross sales tax upon the OTCs was not held to be unconstitutionally vague¹⁰ because the purpose of the statute is understood when considered with its statutory structure and legislative history.¹¹

Negligence Penalties

The District sought negligence penalties based on the contention that the OTCs failed to make a reasonable attempt to comply with the statute. However, the Court found that the OTCs' interpretation of the statute was not unreasonable since there was some uncertainty with respect to the plain language at issue. Whether the OTCs made reasonable attempts to ascertain the correct approach was a genuine issue of material fact and as such, the Court denied the negligence penalties.

Failure to File Tax Returns

The OTCs did not file monthly or annual sales tax returns. Instead, the hotels filed returns for the OTCs' online hotel room transactions. The Court found that the OTCs were vendors making sales at retail subject to the gross sales tax statute, and accordingly, the OTCs were required to file the monthly and annual sales tax returns. In addition, the hotels' returns were insufficient to account for the tax due on the retail price of the rooms. Nonetheless, the Court also found that the OTCs' failure to file returns was not due to willful neglect. The OTCs reasonably interpreted their sales tax obligations in light of the ambiguity in the language of the applicable statute. As a consequence, the OTCs were not liable for the failure to file penalty.¹²

Non-OTC Defendants

Two of the defendants in the case were parent corporations that argued that they could not be classified as OTCs since they did not provide online travel services.¹³ These non- OTC defendants moved for summary judgment on the additional ground that they had no obligations whatsoever under the District's gross sales tax statute. The Court determined that there was a factual dispute as to whether these defendants were merely parent companies or actually OTCs and the District, as the moving party, failed to resolve this dispute. Thus, the Court could not grant summary motion to either side. Rather, it stated the potential need for an evidentiary hearing.

Conclusion

This decision represents a win for another taxing authority pursuing uncollected tax on the retail rate of rooms charged by OTCs. gross sales tax statute, there was room for debate and two conflicting yet reasonable interpretations. Thus, the case also illustrates the need for legislatures to craft statutes with more precision and l provisions to outdated statutory schemes without a complete themselves could explain the lack of clarity. OTCs, faced with an onslaught of actions against them, continue for all state and local hotel or sales taxes imposed on hotel rooms purchased through OTC Web sites.

The Multistate Tax Commission (MTC) is currently working on model legislation that would address this issue, either by requiring hotels to collect and remit tax on the entire retail price, or by requiring the hotels and the OTCs to work together to ensure collection and remittance of the tax on the entire retail price.¹⁴

Footnotes

1 District of Columbia v. Expedia, Inc., Superior Court of District Court of Columbia, Civil Division, Case No. 2011 CA 002117 B, order entered on Sep. 24, 2012.

2 The law in effect prior to April 2011 applied to the majority of the time period at issue.

3 D.C. CODE ANN. § 47-2000 in effect prior to April 2011.

4 D.C. CODE ANN. § 47-2002 in effect prior to April 2011.

5 The Court cited a frequently asked questions publication by the DC OTR for this proposition. See the DC OTR's "Guidance for Questions Involving Nexus," No. 6 (2002).

6 D.C. CODE ANN. § 47-2001(n)(1)(C)(ii)(III).

7 D.C. CODE ANN. § 47-2001(o-1).

8 The Court found that: (i) the OTCs had nexus with the District since they rely upon District hotels to establish and maintain a market in the District; (ii) the tax is fairly apportioned because it is based on the gross charge for the purchase of a room located in the District; (iii) the statute itself does not discriminate against interstate commerce because the District may apply the tax to other local travel intermediaries as well as the OTCs; and (iv) the tax is fairly related to services provided by the District since transients staying at District hotels are protected by the city's police and other services.

9 The District had not yet prosecuted similarly situated online merchant model travel intermediaries.

10 The OTCs alleged that the imposition of the tax violated federal due process.

11 Other affirmative defenses rejected by the Court included issues related to laches, statutes of limitation, waiver of the right to sue, and violation of the Internet Tax Freedom Act.

12 The Court also addressed the claim that the OTCs were required to separately state the sales tax from other charges when charging their customers for hotel rooms. D.C. CODE ANN. § 47-2009. In finding against the OTCs, the Court noted that the District only sought the sales tax owed on the margins the OTCs retained in excess of the wholesale price of the rooms, not sales taxes applied to the discounted amounts that already had been paid over by the OTCs to the hotels.

13 These two defendants were Orbitz Worldwide, Inc. and Expedia, Inc.

14 The MTC's proposal, "Model Statutes for the Collection and Remittance of Lodgings Taxes by Accommodations Intermediaries," has been reviewed by the MTC's Executive Committee, and a public hearing on the proposal was held by the MTC on April 10, 2012.

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