Online Travel Agencies Under Scrutiny for Tax Shenanigans

ExpediaOfficials for some large U.S. cities are claiming that leading online travel agencies such as Expedia (EXPE), Priceline (PCLN), Travelocity and Orbitz (OWW) are collecting state and local hotel occupancy taxes from consumers and remitting only a fraction of the funds, resulting in large tax losses to the governments in question. This is an issue that has surfaced in the past and has received renewed attention given a recent ruling in Texas.

We have a price estimate of $30.60 for Expedia, which is slightly above the current market price.

Are OTAs Keeping Tax Revenues?

The hotels offer OTAs room bookings at a discounted, or "wholesale," price to the otherwise published retail price. While the OTAs earn a profit on every booking, the hotels are able to target higher occupancy levels by distributing hotel room-nights through third parties with access to a wider audience. This is a win-win situation, but here's the catch.

Assume that the OTA offers a room to a consumer for $100 per night. It levies a hotel occupancy tax, which varies among states and cities, at say 10%, amounting to a gross booking of $110 ($100 + $10 for the hotel tax). Let's say the hotel offers the OTA the room booking at a 25% discount; the OTA pays the hotel $75 ($100 minus 25% discount).

The city officials allege that the OTA pays the local government $7.50 (10% of the $75 paid to the hotel) instead of the $10 it collects as a tax from the consumer and claims the $2.50 difference as a processing fee. This differential is a tax loss to the government and appears in the form of higher commission to the OTA.

How this impacts OTAs

We forecast the commission on hotel room bookings to decline from around 24% in 2010 to almost 22% by 2017, the end of our forecast period.

However, current estimates are higher due to the aforementioned differential that exists between the hotel occupancy tax charged to the consumer and that is actually paid to the government. If OTAs are forced to pay a higher hotel occupancy taxes on the total retail amount, the OTAs could see a decline in the commission earned on hotel bookings.

Expedia draws about two-thirds of its bookings from the U.S., and its hotel bookings commissions account for close to 25% of our stock estimate. If we assume a hotel occupancy tax of 5.875% (the rate in New York City), the loss of that extra money it is collecting in "tax" but not currently passing on to the appropriate government would reduce the company's total commissions by around about 0.85%. That puts a 2% potential downside to our current $30.60 Trefis price estimate of Expedia's stock.

You can drag the graph below to see the impact on Expedia's stock price estimate.

View our detailed analysis for Expedia here

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