Part II of TCCRI's recently published State Budget & Taxation Task Force Report discussed an issue of increasing importance to the state: how to regulate emerging business models in a way that rewards innovation but does create an unlevel playing field for more traditional business models. What follows is an excerpt from the Report on that topic.
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House Bill 1525 (86R; Burrows) is a good example of legislation dealing with the issue of newer companies competing on a level playing field. The bill, which passed into law, requires “marketplace providers” to collect sales tax on taxable items delivered to purchasers in Texas. A marketplace provider is a company which runs a marketplace (often a website) and processes sales or payments for sellers. The enactment of HB 1525 followed shortly after the 2018 United States Supreme Court’s decision in South Dakota v. Wayfair, Inc.,[i] in which the court overruled its precedent and held that a state could require “remote” sellers (i.e., those which lack a physical presence in the state) to collect and remit sales tax to the state with respect to their sale of taxable items to persons in the state.
As the court noted in Wayfair, South Dakota (like most states) has a use tax which requires purchasers to submit use tax on their purchases if a remote seller did not collect sales tax. However, as the court further noted, consumer compliance rates regarding the use tax are “notoriously low.”[ii] That fact is not surprising given the difficulty tax authorities in face in auditing the vast number of consumers who make purchases in a given year from remote sellers. Because remote sellers prior to Wayfair were able to sell items to consumers without collecting sales tax (and because most consumers were not paying use tax as they were required to), these sellers had a significant competitive advantage over sellers with a physical presence in the applicable state who had to collect tax. A rational consumer, faced with the choice of purchasing an item from a remote seller on the one hand or a store with a physical presence in his or her state on the other hand, would likely prefer purchasing from the remote seller if all other factors were equal, thereby avoiding the payment of sales tax. To be competitive, the store with the physical presence in this example would be forced to reduce its pre-tax prices in order to offset the tax advantage that the remote seller has.
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It is important to emphasize that the advantage which remote sellers enjoyed pre-Wayfair was inextricably tied to tax administration; if consumers had complied with use tax laws, remote sellers would not have enjoyed an advantage over stores with a physical presence in the relevant state. But because governments have limited resources, ensuring widespread consumer compliance with the use tax is extraordinarily difficult.
Legislation such as HB 1525 should be applauded because it furthers the goal of a competitive marketplace. By making marketplace providers responsible for collecting and remitting sales tax, the bill eliminated artificial advantages some businesses enjoyed over their more traditional competitors. In an ideal marketplace, businesses innovate and develop goods and services which consumers value. Businesses which do a superior job of innovating are rewarded by increased business from consumers. In contrast, a marketplace is warped when government grants one group of businesses an arbitrary tax advantage over its competitors. House Bill 1525 ensures that a remote seller trying to out-compete its rivals with a physical presence in Texas must do so on a level playing field.
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The 86th Legislature considered two bills that were conceptually similar to HB 1525, each of which passed the House but failed to become law. House Bill 3579 (Burrows) would have required online travel agencies (OTAs) such as Expedia and Priceline to collect and remit hotel occupancy tax (HOT) from people who purchase hotel rooms through their websites; currently, hotels alone have that responsibility. House Bill 2872 (Burrows, et al.) would have required companies which pair car owners with people seeking car rentals to collect and remit the motor vehicle gross rental receipts tax. These two bills and HB 1525 generally resemble each other in that they target companies acting as a sort of middleman between buyers (or renters) and sellers online. Notably, substantively similar bills were filed in the 87th Session. House Bill 2889 (Meyer, et al.) was modeled on HB 3579, and House Bill 2415 (Meyer, et al.) was modeled on HB 2872.
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An obvious reason for these bills is tax administration: the Comptroller cannot realistically audit more than a tiny fraction of sellers in the state to determine if they are fulfilling their tax collection and remittance obligations. Just as it is administratively much easier for the Comptroller to audit a single entity (such as eBay) which facilities a vast number of remote sales rather than audit thousands of sellers on eBay, it is much easier to audit a few OTAs rather than hundreds of hotels, and much easier to audit a few car rental platform companies rather than auditing thousands of people renting out their vehicles on these platforms.
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OTAs typically act simply as a distributor for a hotel company rather than actually buying hotels rooms and re-selling them to consumers at marked-up prices. Under the distributor model, a hotel typically agrees to list its room on the OTA’s website at a discounted price in exchange for the increased visibility which the OTA listing provides. The discounted price the hotel and the OTA negotiate is sometimes referred to as the “room price” and is not revealed to the consumer. When a consumer purchases a hotel room on an OTA’s website, it pays a single fee which has three components: the room price, the OTA’s service fee for its services, and a tax recovery charge attributable to the HOT that is due on the room price (again, the consumer does not see this three-part itemization). The service fee charged by the OTA allows it to cover the costs of its various services (search engine capabilities, research on hotel room availability, negotiation with hotels, etc.) and earn a profit. The OTA transmits the tax recovery charge to the hotel, and the hotel in turn remits the HOT to the Comptroller.
Some parties, including many taxing authorities, argue that the amount of the tax base for purposes of calculating the HOT due should include not just the room price but also the OTA’s service fee…
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House Bill 2872 aimed to improve tax administration by making “marketplace rental providers” (MRPs) of motor vehicles responsible for collecting and remitting motor vehicle gross rental receipts tax (GRRT) to state and local taxing authorities. Chapter 152 of the Tax Code subjects “gross rental receipts,” which is defined as “value received or promised as consideration to the owner of a motor vehicle for rental of the vehicle,” to the GRRT.
Currently, MRPs such as Turo and Getaround, sometimes referred to as peer-to-peer car sharing platforms- operate websites which match people seeking rental cars with people seeking to rent out their cars. These companies transmit payment from the renter to the vehicle owner after deducting a fee for their services. As the Comptroller acknowledges, the MRPs have no duty to collect the GRR due.[iii] But because the Comptroller lacks the resources to audit thousands of vehicle owners renting out their vehicles on these platforms, tax compliance by motor vehicle owners using MRPs is presumably quite poor. HB 2872 would have improved tax administration by allowing the Comptroller to focus its resources on a handful of car rental providers.
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The definition of the tax base in an MRP transaction greatly affects competition in the marketplace for rental cars because traditional car rental companies must pay GRRT on their gross receipts. The GRRT is ten percent of gross receipts. Many large urban local governments in Texas levy a sports and community venue tax of up to five percent of the price of a car rental.[iv] In all, traditional car rental companies may be required to increase their fees to consumers by 25 percent just to cover their tax obligations.
In contrast, an MRP currently collects no GRRT with respect to a car rental it facilitates in Texas and vehicle owner compliance with GRRT remission is presumably very poor. Similarly, an MRP and vehicle owners who list on their websites can effectively avoid paying airport concession fees and venue district taxes. Because a person opting to rent a car through a traditional car rental company must pay heavy taxes, if all other factors are equal, he or she will likely prefer to rent through an MRP. This poses the same general problem HB 1525 was designed to combat; an uneven playing field among businesses which is created by inadequate tax compliance by certain consumers.
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The growth of industries such as OTAs and MRPs clearly poses challenges for tax administration. Designating OTAs and MRPs as the parties responsible for collecting and remitting applicable taxes makes a great deal of sense by allowing taxing authorities to greatly reduce the number of entities they must audit to ensure compliance with the law. The Legislature should support such measures because of their potential to make tax enforcement simpler, but should be careful not to discourage innovation. Support for bills such as HB 3579 and HB 2872 should be contingent on ensuring that third party intermediaries are not subject to HOT and GRRT (as applicable) on the value of the services they provide.
Policy Recommendation: Improve Tax Administration in the Marketplace
Following HB 1525 (86R), require marketplace providers connected to the hotel and/or car rental industries to collect and remit applicable taxes so that tax administration is improved. However, avoid the overly broad approach of HB 2415 (87R) and HB 2889 (87R) and define the applicable tax base such that the fees attributable to the marketplace providers’ services are not subject to the tax which the underlying activity (e.g., renting hotel rooms or renting motor vehicles) is.
You can read this section in full and the rest of the report here.
----------------------------------------------------------------------------------- [i] South Dakota v. Wayfair, Inc., "138 S.Ct. 2080 (2018), https://www.supremecourt.gov/opinions/17pdf/17-494_j4el.pdf. [ii] Id. [iii] Comptroller, Private Letter Ruling 20220524125452 (July 15, 2022), https://star.comptroller.texas.gov/view/202207023L. [iv] Comptroller, “Motor Vehicle – Local Sports and Community Venue District Tax for Short-Term Rentals,” https://comptroller.texas.gov/taxes/motor-vehicle/venue.php (last visited January 17, 2023).