#23730-aff in pt & rev in pt-JKK
2006 SD 25
IN THE SUPREME COURT
OF THE
STATE OF SOUTH DAKOTA
* * * *
IN THE MATTER OF CHOICE
HOTELS INTERNATIONAL, INC.,
LICENSE NO.
73-001-521209798E-ST-001, Appellant,
v.
SOUTH DAKOTA DEPARTMENT
OF REVENUE AND REGULATION, Appellee.
* * * *
APPEAL FROM THE CIRCUIT COURT OF
THE SIXTH JUDICIAL CIRCUIT
HUGHES COUNTY, SOUTH DAKOTA
* * * *
HONORABLE MAX A. GORS
Judge
* * * *
JOHN L. BROWN of
Riter, Rogers, Wattier & Brown
Sioux Falls, South Dakota Attorneys for appellant.
HARVEY M. CROW, JR.
SD Department of Revenue
and Regulation
Rapid City, South Dakota Attorney for appellee.
* * * *
CONSIDERED ON BRIEFS
ON FEBRUARY 13, 2006
OPINION FILED 03/15/06
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KONENKAMP, Justice
[¶1.] South Dakota law exempts travel agent services from sales tax.
Nonetheless, the Department of Revenue, reasoning that an entity acting as a pass
through for tax-exempt funds was not itself specifically exempt from paying the tax,
issued a certificate of assessment against a hotel franchisor for sales tax on travel
agent commissions it collects from its franchisees and pays to travel agents. The
Department also assessed the franchisor for unpaid sales tax on fees collected for its
customer incentive program. As to the travel agent fees, we hold that no sales tax
applies because the franchisor acts strictly as a pass through in collecting and
distributing tax exempt funds. With respect to the incentive program fees, however,
we conclude that they are collected as part of a service and therefore are subject to
sales tax. We affirm in part and reverse in part.
Background
[¶2.] Choice Hotels International, Inc. is the franchisor of eight hotel
brands: Clarion, Quality, Comfort, Comfort Suites, Sleep Inn, EconoLodge, and
Rodeway. After conducting an audit, the South Dakota Department of Revenue and
Regulation issued a certificate of assessment against Choice for sales tax and
interest totaling $66,497.80. Two of Choice’s programs were scrutinized in the
audit resulting in the sales tax assessment: the Travel Agent Centralized
Commission Program and the Choice Privileges Program. Choice disputed the
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taxability of both programs and contested the assessment, but it was unsuccessful
in its administrative and circuit court appeals. 1
[¶3.] Designed to act as a pass through for travel agent commissions, the
Travel Agent Centralized Commission Program works within Choice’s reservation
system. Choice makes this a mandatory program in which all hotels must
participate. It was developed by Choice because “[t]ravel agents account for up to
40% of all reservations,” and there was a “potential for even higher reservation
volume from travel agents[.]” After a reservation is booked with a Choice franchisee
hotel through a travel agent, all the information is sent to a third party database,
and then Choice sends an invoice to each franchisee.
[¶4.] Itemized in each invoice is a forty-eight cent processing fee Choice
charges for each transaction and the commission owed by the franchisee to the
travel agent for each reservation. A reminder at the bottom of Choice’s invoice
explains that “Commissions are NOT PAID to the Travel Agency until [the
franchisee’s] payment has been received.” Failure to pay the amount due on the
invoice (the processing fee and commission) constitutes a breach of the franchise
agreement.
[¶5.] After the invoice is received, the franchisee is required to verify the
information and make any necessary changes. If a guest does not actually use the
reservation, for example, the franchisee would deduct the commission charged.
1. Choice paid the disputed amount of tax to stop interest from accruing, subject
to a refund in the event its appeal was successful.
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Once the invoice information is verified by the franchisee, it sends payment to a
separate account owned by Choice. 2 From that account, all the commissions
collected are sent to the travel agents. The forty-eight cent processing fees are
transferred to Choice’s operating account. Accordingly, Choice argues that the
travel agent commissions it processes are exempt under South Dakota statutes, and
transferring these commissions from the franchisees to the travel agents should not
make them taxable.
[¶6.] Choice also challenges the taxability of the monies collected through its
Choice Privileges Program. This program was developed by Choice as an incentive
plan for member guests to stay at franchisee hotels. The hotels are not required to
participate in or offer the program to guests. However, if a franchisee elects to
participate, it is required to pay Choice “$2.50 for each night a member of the
Choice Privileges Program stays at that hotel.”
[¶7.] According to Choice, this $2.50 is used to reimburse participating
franchisees when a member of the program stays at the franchisee for free. A
member would stay for free after spending ten nights at qualifying franchisees.
And because the guest is not required to spend the free eleventh night at the same
franchisee where the qualifying nights were accumulated, Choice argues that the
$2.50 is collected only to offset franchisee loss. Therefore, Choice asserts that the
service should not be considered taxable, as Choice does not engage in an activity
for a fee, retainer, commission, or other monetary charge.
2. The account is administered by a third party and is entitled Choice Hotels
International Travel Program.
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[¶8.] These arguments were unsuccessful in Choice’s administrative and
circuit court appeals. It now asks us to review the following questions: (1)
“Whether travel agent commissions, otherwise exempt from sales tax under South
Dakota statutes, are taxable receipts to a franchisor, which collects such
commissions and disburses the commissions to the travel agent?” (2) “Whether the
collection of monies from individual franchisees in order to reimburse a franchisee
for a qualifying stay under a rewards program constitutes gross taxable receipts?”
Standard of Review
[¶9.] In administrative appeals, our standard of review is governed by
SDCL 1-26-36. “We give deference to the agency on factual matters, applying the
clearly erroneous standard of review. ” Watertown Coop. Elevator Ass’n v. S.D.
Dept. of Rev., 2001 SD 56, ¶10, 627 NW2d 167, 171 (citation omitted). Questions of
law, such as the question whether a statute imposes a tax under a given factual
situation, are reviewed de novo. Id. (quoting S.D. Dept. of Rev. v. Sanborn Tel.
Coop., 455 NW2d 223, 225 (SD 1990) (additional citation omitted)). “Statutes
allowing tax exemptions are exactingly and narrowly construed in favor of the
taxing entity.” Id. (citing Matter of Quality Service Railcar Repair Corp., 437 NW2d
209, 211 (SD 1989)).
Analysis and Decision
1. Travel Agent Centralized Commission Program
[¶10.] Choice does not dispute that its forty-eight cent processing fee is a
taxable gross receipt. However, it argues that transferring payment of the exempt
travel agent commissions on behalf of the franchisees should not make the
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commissions taxable to Choice. Franchisees can pay the travel agent commissions
directly to the travel agents. Choice merely acts as a pass through.
[¶11.] The Department, on the other hand, asserts that Choice’s
circumstances do not fit the usual exemption for a travel agent commission. The
exemption would apply, according to the Department, if the franchisee hotels paid
the travel agent commissions to the travel agents directly. Here, however, the
franchisees are making payment for travel agent commissions to Choice, which is
not a travel agency. 3 Accordingly, the Department contends that Choice has failed
to prove that it is entitled to the exemption under SDCL 10-45-12.1.
[¶12.] A tax is imposed, under SDCL 10-45-4, “upon the gross receipts of any
person from the engaging or continuing in the practice of any business in which a
service is rendered.” Further, any service is subject to sales tax unless specifically
exempted. Id. A service is defined in SDCL 10-45-4.1 as “all activities engaged in
for other persons for a fee, retainer, commission, or other monetary charge, which
activities involve predominantly the performance of a service as distinguished from
selling property.” In SDCL 10-45-12.1, certain services are delineated as exempt
from sales tax under SDCL ch. 10-45.
[¶13.] It is undisputed that travel agent services are exempt from sales tax
under SDCL 10-45-12.1. Yet, for Choice to be entitled to an exemption on the travel
3. The exempt services enumerated in SDCL 10-45-12.1 are from the Standard
Industrial Classification Manual. Travel agent services are grouped under
“arrangement of passenger transportation (group no. 472).” The Department
argues that Choice must be primarily engaged in furnishing travel
information and arranging lodging for travelers to be entitled to the
exemption.
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agent commissions it processes, it has the burden to prove such exemption. See
Matter of Pam Oil, Inc., 459 NW2d 251, 255 (SD 1990). According to the
Department, Choice was required to identify a specific statute that exempts a “pass-
through” service.
[¶14.] “This [C]ourt has repeatedly held that the rule that laws exempting
property from taxation should be strictly construed in favor of the taxing power does
not call for strained construction, but must always be reasonable and will not be
applied to defeat the expressed intent of the Legislature.” In the Matter of Veith,
261 NW2d 424, 426 (SD 1978) (citing State v. Erickson, 44 SD 63, 182 NW 315
(1921); State v. Knudtson, 65 SD 547, 276 NW 150 (1937)). To interpret the
exemption as narrowly as the Department has done in this case contravenes the
legislative intent that travel agent commissions be exempt from sales tax.
[¶15.] The commissions would be exempt if paid by the franchisees to the
travel agents. Here, Choice sends invoices to the franchisees indicating what
amounts the franchisees owe the travel agents for commissions earned on
reservations made at those franchisee hotels. The franchisees then have the option
of paying the travel agents directly or submitting payment for the commissions in
one payment through the Travel Agent Centralized Commission Program account
owned by Choice. If franchisees elect to make payment through the agent
commission account, Choice does not retain any portion of the commissions; all
commissions are paid to the travel agents. 4 Therefore, we conclude that it is
4. The Department does not assert that Choice retains any portion of this ten
percent commission.
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unreasonable to hold that solely because the commissions are collected by the
franchisor from the franchisees and then paid to the travel agents they are no
longer exempt from tax. See Veith, 261 NW2d at 426. Choice met its burden to
show that the travel agent commissions were exempt from tax under SDCL 10-45-
12.1.
2. Choice Privileges Program
[¶16.] According to Choice, all monies collected through the Choice Privileges
Program are awarded out of the program. As a result, Choice maintains that there
is no taxable service because it does not retain a fee for this transaction. “As
required by this statute, we use the predominant activity test in deciding if the
services were subject to sales tax.” Watertown Coop Elev. Ass’n, 2001 SD 56, ¶12,
627 NW2d at 172. From examining the transaction, it is evident that Choice offers
the Choice Privileges Program to the franchisees in return for a fee. As we said in
Watertown Coop, we focus on the transaction. See id.
[¶17.] This program was created to entice guests to stay at franchisee hotels.
One guest benefit is that after staying ten nights, the eleventh night is free. When
a guest receives a free night’s stay, the franchisee suffers a loss. In return for the
franchisee’s participation in the program, Choice promises to reimburse the
franchisee for the cost of the guest’s room. All that is required is payment of $2.50
each time a Choice Privileges member stays at that franchisee’s hotel. This
constitutes an activity “engaged in for other persons for a fee. . . .” See SDCL 10-45-
4.1. Thus it is a taxable service under SDCL 10-45-4.
[¶18.] Affirmed in part and reversed in part.
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[¶19.] GILBERTSON, Chief Justice, and SABERS, ZINTER, and
MEIERHENRY, Justices, concur.
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