During the Great Depression, the taxi industry boomed in the United States. This growth was fueled, in part, by the fact that the industry was largely unregulated. With many unemployed and underemployed individuals in need of extra money at the time, driving a taxi was a popular pursuit. At that time, drivers used “call boxes” located on city streets to communicate directly with the dispatch center to determine where to pick up the next passenger and what to charge for the ride. 

As the number of taxi drivers exploded, the fares for rides fell. However, streets soon became overly congested with taxis causing a public outcry. The adopted solution was to regulate the taxi industry through the “medallion” system.  Only a taxi operating under a government-issued medallion was permitted to provide taxi services. Through the issuance of medallions, a state or local government could limit the number of taxis – and, therefore, congestion – on its streets. The medallion system is still the prevailing system in effect in most taxi markets today.

Fast forward to the present and the transportation services industry is again reborn through the use of a variety of transportation technology companies (TTCs). Now, locating a ride is as simple as tapping an application on our smartphones. How times have changed. Or have they? Like the taxi industry in the 1920s and 1930s, these new companies such as Uber and Lyft remain less regulated than taxi companies, but the incentive for driving as an independent contractor under an agreement with a TTC is similar to that experienced during the Great Depression. Most individuals drive for a TTC as a way of supplementing their income.  Finally, mirroring the supply and demand economics of the past, as TTCs have flourished, the cost of a ride has fallen.

Seeking additional sources of sales tax revenue, state and local taxing authorities have recently become more aggressive in their method of taxing TTCs. Some of these taxing authorities take the position that TTCs are not substantially different from traditional taxi companies and should be liable for sales tax to the same extent as a taxi operator.

However, TTCs merely facilitate the connection between riders needing transportation services with drivers willing to provide them. TTCs use proprietary applications and advanced technology on our smartphones to help supply meet demand. Unlike traditional taxi companies, TTCs do not own the vehicles. Further, drivers enter into license agreements permitting them to use a TTC’s application. The drivers are independent contractors and the TTCs do not control when drivers work and the drivers are required to pay their own personal expenses.

Despite these major differences, certain states – most recently, Ohio and Georgia – have issued sales tax assessments to TTCs seeking sales tax on the transportation services provided by third-party drivers. In defense of these assessments, taxing authorities often reference nebulous idioms such as “leveling the playing field.” However, the faulty assumption underlying this justification is that both “players” are on the same “field.” TTCs and traditional taxi businesses are not similar economic “players.” TTCs are compensated for providing services but do not provide transportation services. A TTC primarily generates revenue from two sources: (1) its ability to quickly and efficiently connect – through a smartphone application – drivers with riders and (2) by providing payment processing services for its drivers. By contrast, a traditional taxi company earns revenue from the actual provision of transportation services provided to customers who contact them directly.

In their defense against these sales tax assessments, TTCs can learn a lot from the experience of online travel companies (OTCs).  Over a decade ago, one of the hotbeds of state and local tax litigation involved the treatment of OTCs.  Before the emergence of OTCs, a traveler would research and contact a hotel directly for a reservation.  OTCs leveraged the connectivity of the internet to more efficiently link travelers with hotels through their personal computers. The growth of the OTC industry offered travelers a lower rental rate than they would have received had they gone about it the “old fashioned” way. OTCs also, depending on the particular business model employed, made life easier for hotels by processing payments. State taxing authorities, resorting to the “duck test,” sought to treat the OTCs as the party actually renting or leasing the hotel room to the customer. OTCs argued, mostly successfully, that its revenues were specifically derived from the facilitation services it provided. The hotels, the OTCs contended, were independent third parties not otherwise controlled by the OTCs. In substance and in form, the OTCs maintained, the hotels were the parties actually renting or leasing the rooms. Many state courts agreed with this line of reasoning.

At least two state taxing authorities are now pursuing TTCs. Yet, the recent fight between TTCs and state and local taxing authorities could be a case of history repeating itself. The only difference between the operation of OTCs at that time and TTCs today is the e-commerce channel through which transactions are completed.  Unfortunately, it appears that the illusion created by the “duck test” is once again blinding taxing authorities to the economic realities of the underlying transactions.  As the famous lawyer Clarence Darrow once said, “History repeats itself. That’s one of the things wrong with history.”