Taking You Inside Expedia's Hotel Merchant Model

The South Carolina Administrative Law Court in February ruled that Expedia owes the state almost $6.4 million (actually $6,376,454.71) in accommodations tax for its merchant model hotel bookings from July 2001 to June 2006.

As I wrote, Expedia and the other major online travel agencies face these sorts of administrative tax proceedings by states and municipalities across the country.

For example, in addition to South Carolina, Expedia has received tax assessments or notices of audit from the states of Texas, Pennsylvania, Florida, Georgia, Indiana, New Mexico, New York, West Virginia, Wisconsin and Kansas.

And, as Expedia fends off and fights for its position in these state proceedings, the above list doesn't even take into account all of the counties and cities that independently are going after Expedia and other online travel agencies on similar grounds.

Although many of aspects of the OTA merchant model are generally known to industry peeps, the South Carolina decision puts it all together in a way that I found very informative.

The South Carolina court said that Expedia, which fully cooperated with the audit, contracted with 364 South Carolina hotels on a merchant-model basis during the five-year period under review.

Both the state and Expedia stipulated that the merchant model works like this:

• The Expedia-hotel contracts assign pre-negotiated net rates for rooms;

• The hotel makes available to Expedia a base number of rooms;

• But "the hotel retains the right to book the reservations itself through channels other than" Expedia's;

• Expedia faces no liability if it doesn't sell the number of base rooms available;

• Expedia's retail rate to consumers includes a mark-up of the net rate, an additional margin in the form of service fees, other fees including resort fees, and tax recovery charges based on the net rate;

• Expedia is the merchant of record in the consumer transactions;

• The hotel invoices Expedia for the net rate and the accommodations tax, which is based on the net rate.

• Expedia pays the invoice to the hotel for the net rate plus a tax recovery charge based on that net rate.

• Expedia has not filed accommodations-tax returns and has not paid accommodations tax to the South Carolina Dept. of Revenue;

• And, the hotel pays accommodations tax to the state based on the net rate it gave Expedia.

Hence the gap and the issue because South Carolina -- and others of the thousands of taxing jurisdictions in the U.S. -- want Expedia and other online travel agencies to pay tax on Expedia's margin, including service fees.

The South Carolina administrative court found that Expedia "was liable for sales tax on its entire gross proceeds of sale, including not only the net room rate, but also Petitioner's [Expedia's] margin and service fees."

Expedia and other online travel agencies have won a handful of the court decisions that were decided on the merits, but they have faced setbacks in Columbus, Ga., and adverse administrative proceedings in locales including Anaheim, Calif., and the states of South Carolina and Indiana.

In addition, a U.S. District Court in San Antonio, Texas, last year certified the City of San Antonio's hotel tax suit against the major OTAs as a class action on behalf of all the state's municipalities that collect occupancy taxes.

It is easy to see why, facing the pressure from thousands of tax authorities, Expedia, Hotels.com, Travelocity, Priceline and Orbitz have adopted what I referred to in a podcast as a Google Earth strategy, placing pins on a map and removing their hotel sales from cities where tax rulings have gone the wrong way.

The OTAs, engaged in this game of hardball, may find new allies in local hotels.

David Cassell, general manager of the Columbus Marriott in Columbus, Ga., told me that the city's hotels are down hundreds of thousands of dollars in revenue since the OTAs pulled out of the city and the properties have been unable to recoup the sales through discounting and other promotions.

Cassell believes that the city is shooting itself in the foot. "In my opinion, the taxes lost on the revenue that would have been generated could have far outweighed the money they [the city] would have received in back taxes," Cassell said.

The Google Earth hotel-tax battle continues.