All material subject to strictly enforced copyright laws. © 2022 ITR is part of the Euromoney Institutional Investor PLC group.

Hotel tariff: More complex than just a simple CUP analysis without adjustments

Sponsored by

eygreece.png
TP and associated issues to determine a market value hotel tariff pose considerable challenges and opportunities

Sakkara Simón and Ricardo Barbieri of EY Mexico consider that other relevant variables should be included in applying the comparable uncontrolled price method on hotel tariffs.

The hotel industry is volatile. Workloads and per night tariff change exponentially from one week to another. This is the result of a vortex caused by seasonality in the hospitality industry. The annual  planning of a hotel is directly related to this variable, therefore, the way in which a hotel prepares itself to face different seasons will have a direct impact on its financial performance, which should be taken care of in special detail when its income, defined by its rate per night, is controlled in an inter-company transaction. 

Tourist zones around the world have two seasons: high and low. High season is when the number of tourists tends to increase in large proportions, causing hotel occupancy to reach up to 100%. On the other hand, low season is the one in which hotel occupancy oscillates between 60% and 70% depending on the destination, usually on periods when most people are either working or studying. 

Low season is present three times per year: January to March, after Christmas holidays and before spring-break; May to June, after Easter Week and before summer vacations; and September to November, rain and hurricane season in beach areas. 

However, it is important to mention that with the presence of COVID-19, the seasonality has changed given that home office has become a constant, which has allowed people to travel at different times of the year and for longer periods. 

As mentioned before, seasonality is a key variable to determine hotel tariffs which are related to occupancy. These rates can be reduced during the low season up to a 50% compared to the highest price of the high season. 

Regardless of seasonality, the determination of hotel tariffs is based on a complex algorithm that considers: 

  • The destination’s offer at the time of reservation (occupancy), that is measured with the number of available rooms. Derived from hotel closings due to COVID-19’s presence, this offer contracted, representing a price-rising opportunity to those players able to keep their doors open;

  • Market supply and demand, where capacity is the key variable;

  • Travel sentiment reports that allow hotels to know how travelers feel about the destination;

  • Booking window and room inventories control;

  • Hotel’s online category and reputation, and its customer satisfaction index;

  • Competitor´s rates (by brand, by destination and by active level);

  • Marketing investment;

  • Customer volume by geographic precedence and target market;

  • Sales market as well as guaranteed quotas; and

  • Government regulations regarding COVID-19 for the country of destination and country of origin including security, hygiene, and infection protocols.

From a transfer pricing (TP) perspective, when the sale/purchase of tariffs is documented, the reference method is the comparable uncontrolled price (CUP). 

The CUP method compares the prices of goods and services transferred in a controlled transaction (affiliated companies) with the price charged for goods and services transferred in a comparable independent transaction (third parties) under similar circumstances. As such, given that a hotel offers the same service to third parties and related parties, the internal comparable can be used to document the transaction in a direct and reasonable way. 

Nonetheless, there may be differences to adjust, specially derived from the volume, the production level associated to the sales channel, and the seasonality. 

Existing sales channels in the hospitality industry include tour operators, OTAs (online travel agencies), travel agencies and the direct channel. 

In traditional channels, agencies and tour operators, usually establish annual fees and discounts in their agreements according to seasonality. New channels, like OTAs, are based on dynamic net rates, and the contract only establishes the profit margin for the agency. 

The difference on the tariff price oscillates approximately between 25% and 10% for the final customer (operator’s commission), depending on each channel’s production level. In addition to this differential, marketing support is agreed upon (investment quotas) to reinforce a holiday, a promotion, or a campaign, which in average could be between 5% to 10% of the channel’s total sales. Finally, there are additional discounts that range between 2% and 8% depending on the price level and occupancy at the moment of the discount.

Although the market shows defined tendencies, when the inter-company tariff is documented, it usually does not reflect these trends, and on the contrary, an average annual tariff linked to a quota or minimum guaranteed amount is agreed upon.  

As a result, our challenge as consultants, is to identify and correctly measure the internal comparables as to consistently reflect the behaviour of supply and demand between third parties by considering all the aforementioned variables, and consequently, adjust the external comparables to the transaction under analysis. 

Additionally, it should be verified that the rate sold to the final client covers the market profit margin associated to each of the operating and marketing functions in the value chain of the company or hotel group, even when there is a guaranteed quota. 

Clearly, TP and associated issues to determine a market value hotel tariff pose considerable challenges, but also opportunities for hotel groups, that should consider substantive, economically driven risk management strategies and use these to balance three important and not necessary competing goals: 

  • Retain economic substance from the different tariffs according to supply and demand in the different periods of the year;

  • Manage the economic risks arising from inter-company structures that are not agreed between independents; and

  • Comply with local TP requirements while using TP proactively to achieve their own business objectives.

 

Sakkara Simón

Partner, EY

E: sakkara.simon@mx.ey.com

 

Ricardo Barbieri

Partner, EY

E: ricardo.barbieri@mx.ey.com 

 

more across site & bottom lb ros

More from across our site

The Biden administration is about to give $80 billion to the Internal Revenue Service to enhance the tax authority’s enforcement processes and IT systems.
Audi, Porsche, and Kia say their US clients will face higher prices under the Inflation Reduction Act after the legislation axes an important tax credit for electric vehicle production.
This week Brazil’s former President Luiz Inacio Lula da Silva came out in support of uniting Brazil’s consumption taxes into one VAT regime, while the US Senate approved a corporate minimum tax rate.
The Dutch TP decree marks a turn in the Netherlands as the country aligns its tax policies with OECD standards over claims it is a tax haven.
Gorka Echevarria talks to reporter Siqalane Taho about how inflation, e-invoicing and technology are affecting the laser printing firm in a post-COVID world.
Tax directors have called on companies to better secure their data as they generate ever-increasing amounts of information due to greater government scrutiny.
Incoming amendments to the treaty could increase costs on non-resident Indian service providers.
Experts say the proposed minimum tax does not align with the OECD’s pillar two regime and risks other countries pulling out.
The Malawian government has targeted US gemstone miner Columbia Gem House, while Amgen has successfully consolidated two separate tax disputes with the Internal Revenue Service.
ITR's latest quarterly PDF is now live, leading on the rise of tax technology.
We use cookies to provide a personalized site experience.
By continuing to use & browse the site you agree to our Privacy Policy.
I agree