Challenges of Taxing the Sharing Economy

Posted on 11-25-2015

By: Jessica L. Kerner

IN 2007, A HOTEL ROOM SHORTAGE IN SAN FRANCISCO prompted two roommates to create a website to rent out air mattresses in their apartment. Less than eight years later, the company they founded, Airbnb, has been valued at more than $25 billion.1 The success of Airbnb is mirrored in other “peer-to-peer” startups, such as Uber, Lyft, and HomeAway, which are capitalizing on technological advances that have allowed the creation of platforms to directly connect buyers and sellers.

The sharing economy has led to a host of tax headaches for taxpayers and tax authorities, in large part because of the new business models enabled by new technology that have not been contemplated by existing tax laws. Although this problem is not unique to the sharing economy (it has long been an issue in other industries, such as the telecommunications industry, where technological advances have surpassed existing tax laws), the proliferation of peer-to-peer startups in the sharing economy has garnered significant attention for the large number of federal, state, local, and international tax issues it has raised in a relatively short period of time. Many complex tax issues are raised by the sharing economy. A sample of the types of issues that arise in attempting to tax the sharing economy highlight the challenges that may be encountered in this endeavor.

How the Sharing Economy Operates

The sharing economy is driven by businesses that provide Internet- based platforms connecting buyers and sellers of goods and services. Two examples of the sharing economy at work are the accommodation and transportation markets. The short-term room rental market has been revolutionized by platforms like Airbnb, HomeAway, VRBO, and Flipkey that allow individuals to advertise entire homes or rooms in homes as short-term rentals. On Airbnb alone, rooms are available in 190 countries and 34,000 cities. In the transportation space, ride-sharing companies like Uber and Lyft are taking market share from traditional providers like taxi and limousine services. Uber is available in 60 countries worldwide, and Lyft operates in about 60 cities in the United States.

Although home rentals and ride sharing are increasingly mainstream and well known, peer-to-peer startups exist in many industries. For example, individuals can rent out their cars using RelayRides, lend money using Prosper or Lending Club, get paid for performing odd jobs through TaskRabbit, and host meals with Feastly.

Similar peer-to-peer transactions have taken place for decades, but the frequency of these transactions has increased dramatically with the growth of online platforms connecting buyers and sellers, creating multibillion-dollar businesses. According to Airbnb, 17 million guests used Airbnb this summer, setting a record of nearly 1 million rentals on August 8, 2015.2 Technological changes are the primary enabler of this growth. Businesses based on the Web require little infrastructure and can expand worldwide in a relatively short period of time. The growth of Airbnb to a value of more than $25 billion in seven years again provides an excellent example.3 By comparison, the first Marriott hotel opened in 1957, and Marriott was valued at approximately $21 billion in 2015. Uber, founded in 2009, has had a similar trajectory to Airbnb, having obtained a nearly $51 billion valuation as of July 2015.4

Taxes and the Sharing Economy

Sales Tax Collection and Tax Administration

One of the difficulties with taxing the sharing economy is how to apply and collect sales and transaction taxes, such as the hotel occupancy taxes that may apply to short-term rentals. In many cases, tax laws do not place the burden for collecting these taxes on the company that facilitates the peer-to-peer transaction, but rather on individual sellers. However, these taxes are often not collected. This occurs for a variety of reasons. For example, consider the accommodation industry. In many cities, rentals of less than 30 days are illegal, and thus sales and occupancy taxes that would otherwise apply to these transactions are not collected. An October 2014 report by New York’s Attorney General estimated that private, short- term rentals booked through sites like Airbnb generated more than $33 million in unpaid occupancy taxes and fees in New York City between 2010 and mid-2014.5 The report also estimated that 72% of Airbnb’s rentals during this timeframe violated New York zoning and other laws, such as the requirement that apartments can only be rented out for less than 30 days if the host is also staying in the apartment. Even where short-term rentals are legal and transaction tax laws place the burden of tax collection on the individual seller, the tax may not be remitted because it is burdensome for the individual seller to file the appropriate tax return and remit the tax to the state. It is also burdensome for the taxing authority to receive large numbers of small remittances and to monitor the compliance of the thousands of individuals who use peer-to-peer websites.

In some localities where short-term rentals had been illegal or there were questions about their legality under existing laws, the laws have been changed. One of the larger cities to amend its laws on short-term rentals is San Francisco, which passed a short-term residential rentals ordinance that requires owners and tenants of units to apply for permission from the city’s planning department to rent out their units. Applicants must meet a number of conditions, including living in the unit for most of the year, obtaining a business registration certificate, and providing proof of liability insurance. Once registered, the resident may rent out the unit while they are not present for up to 90 nights per calendar year. There is no limit on the number of nights that the unit can be rented while the resident is present in the unit. The resident, also known as the host, is required to file and pay San Francisco’s 14% transient occupancy tax (TOT) on the rental, unless the platform through which the property is rented is paying the tax on behalf of the host. Airbnb collects and remits the TOT for its San Francisco hosts. According to its website, Airbnb also collects and remits taxes in about a dozen other local jurisdictions and statewide in North Carolina, Oregon, Rhode Island, and Washington.

Legislative Challenges with Modernizing Tax Laws

One of the reasons that state and local governments may not have addressed tax issues presented by the sharing economy is that they may be more focused on non-tax concerns. The non-tax-related issues may be seen as more pressing than the tax concerns as they include questions of safety, such as whether non-residents in a short-term rental would be prepared in case of fire, and concerns about the changing character of neighborhoods when short-term renters displace longer-term residents. In cities where housing is already limited, there may be concerns that widespread conversion of apartments into short-term rentals will increase housing shortages and further drive up housing costs. There are also issues related to competition with existing businesses and the potential for market distortions. For example, highly regulated taxicabs are forced to compete with unregulated companies that provide ride-sharing platforms. And, there may be insurance issues. For example, many individual insurance policies do not cover policyholders who use their vehicles on a for-hire basis. Many jurisdictions have existing laws and regulations to address some of these issues, and often these laws make sharing transactions illegal. Some jurisdictions have amended their laws and permit sharing companies to operate, and individual transactions to take place, provided they follow the new rules. For example, earlier this year Virginia passed a law regulating transportation network companies (TNCs), which includes ride- sharing companies. TNCs are permitted to be licensed in Virginia by the state Department of Motor Vehicles provided they meet certain requirements. These requirements include that the TNC must ensure that all drivers are at least 21 years old and have a valid driver’s license, and the TNC must conduct background checks on all drivers. The vehicles used to transport passengers must be titled, registered, and properly insured. There are also licensing fees and annual service fees.

Another reason that legislatures may not have addressed tax issues is that tax reform, particularly where it is viewed as raising taxes, is often politically unpopular. Politicians often do not want to be in the position of imposing new or higher taxes, particularly on new and often very popular services.

Even when laws are updated to take into account new business models, those new laws may quickly become outdated. This happened recently in California. The California Public Utility Commission (CPUC) promulgated regulations addressing ride sharing. The regulations require TNCs to obtain a license from the CPUC, require a criminal background check on each driver, set up a driver training program, hold a certain amount of commercial insurance, and conduct car inspections. However, shortly after the California regulations were promulgated, the TNC model changed— the TNC companies added carpooling features. The CPUC asserted that the carpool feature violated California law, which prohibits transit companies from charging riders individually. The CPUC said that the ride-sharing companies either needed to request amended permits or obtain a legislative change.

The failure of tax laws to keep up with technology and changing business models has been a recurring theme in the taxation of several industries, including the telecommunications industry. For example, some may remember when long-distance telecommunications services were sold by the minute based on not only the length, but also the distance of the call. At that time, a Federal Excise Tax (FET) was imposed on long-distance service. The FET defined long-distance service as a service for which the tax varied based on the amount of time and distance of the call. When long-distance carriers stopped varying the charge for calls based on distance, the IRS took the position that the FET still applied. Long- distance carriers disagreed, and litigation ensued. Eventually, the IRS acquiesced. However, telecommunications tax controversy has continued as telecommunications technology has evolved. When voice over Internet protocol (VoIP) service became widely available in the early 2000s, the federal, state, and local tax treatment of this service was often unclear. Tax laws had generally been written to apply to traditional landline telephone services (e.g., local exchange telephone service and long-distance telephone service). Tax laws that were narrowly drafted to apply to exchange telephone service clearly did not apply to VoIP services. Other statutes were more unclear and created controversy and litigation over whether the tax applied to VoIP services. Over time, the laws were changed to apply more broadly, some even attempting to apply to future telecommunications service offerings.

Now, telecommunications technology has taken another giant leap forward with cloud-based telecommunications, and laws written for VoIP service are again outdated. It is often difficult to determine the appropriate sales or telecommunications tax treatment for these cloud-based services. Most sales tax laws do not contemplate these types of services, particularly with respect to determining which jurisdiction’s taxes apply to the service. The laws have again failed to keep up with the technological changes, creating uncertainty and potential revenue loss for taxing jurisdictions. State legislatures are simply unable to keep up, as the legislative process is often long, and technology and business models change rapidly. Given the technological advances enabling new and continuously evolving business models associated with the sharing economy, similar risks are present in attempting to update laws to apply to the sharing economy. It is difficult to draft laws that will apply to products and services that have not yet been invented and business models that are not yet in existence. Where laws are updated to reflect current business models and product and service offerings, the laws may fail to keep up as technology and business models continue to change.

Tax Policy

In taxing the sharing economy, it is important not to create separate laws that apply only to the sharing economy. Doing so would violate two central tenets of tax policy: that taxpayers should be treated uniformly and that similar services and goods should be taxed the same. When similarly situated companies, or similar products and services, are subject to different tax treatment and to different regulations, it can result in unfair competition, which may lead to distortions in the market and litigation. For example, traditional taxi services are often heavily regulated by cities that collect substantial fees from taxis in exchange for licenses to operate. Ride-sharing companies (and their drivers) have largely operated outside of these regulations and have not been subject to these significant fees, which some attribute to being one of the reasons for their dramatic growth. With lodging, sales and hotel taxes can be as high as 10-20% depending on the location. When short-term rentals do not include these taxes, they have an advantage over hotels and other lodging establishments that are collecting these taxes, as it reduces the cost of the room for the consumer. However, legislatures and regulators must be careful when attempting to tax and regulate new business models that new disparities are not created.

The challenge of not creating new disparities when attempting to tax new services has been an issue in the telecommunications industry in the taxation of direct broadcast satellite (DBS) services, such as the services provided by Dish Network. With DBS services, which compete with traditional cable television service, customers receive television and other programming to their location through a satellite. When the relatively new DBS services were introduced, many existing taxes and regulatory fees that applied to cable television services, including franchise fees for the use of the public right-of-way to lay cable, did not apply to the new services. In modernizing their laws to apply taxes to DBS services, some states imposed taxes on DBS services that did not apply to cable services, or imposed taxes at rates that were higher than the taxes imposed on cable services, in an attempt to equalize the burden of taxes and fees borne by cable and satellite. The disparate treatment led to litigation as satellite providers challenged the laws as discriminatory. Many of these cases have often involved multiple appeals, including a Massachusetts case that the taxpayer appealed to the United States Supreme Court.6

Legislatures are again in the position of having to address the disparate treatment between largely unregulated new businesses that are often competing in industries with existing highly regulated and taxed businesses. Legislatures will need to be careful in attempting to equalize the burdens in order to not create the types of disparities they have in the past if they want to avoid litigation that is costly to both government and taxpayers.

Conclusion

As the sharing economy continues to grow and evolve, tax laws and policies will need to be continuously monitored, updated, and reformed. In attempting to modernize laws and level the playing field between existing and new business models, lawmakers should apply the usual principles guiding tax policy. Although governments have historically struggled to update tax laws and policy in response to technological changes, it is clear that technology will continue to advance and that governments need to be similarly forward-thinking in their tax policies with the goal of addressing new tax issues without stifling innovation.

*Jessica Kerner J.D., LL.M. is a Content and Product Initiatives Manager for Lexis Practice Advisor

1. “Value of Airbnb Hits $25.5 Billion with Latest Round,” The Wall Street Journal (June 29, 2015).
2. See “Airbnb Summer Travel Report: 2015,” available here: http://blog.airbnb.com/wp-content/uploads/2015/09/Airbnb-Summer-Travel-Report-1.pdf.
3. “Value of Airbnb Hits $25.5 Billion with Latest Round,” The Wall Street Journal (June 29, 2015).
4. “Uber Valued at More than $50 Billion,” The Wall Street Journal (July 31, 2015).
5. The report is available at: http://www.ag.ny.gov/pdfs/Airbnb%20report.pdf (last visited Oct. 16, 2015).
6. DIRECTV, LLC, et al. v. Mass. Department of Revenue, 470 Mass. 647, 25 N.E.3d 258, 2015 Mass. LEXIS 94 (Mass. 2015), petition for cert. filed (U.S. June 18, 2015) (No. 14-1499).