Groupon’s legal risks and hidden gift to merchants

By Felix Salmon
June 16, 2011
Benjamin Edelman and Paul Kominers have a fantastic post up about the various legal pitfalls facing Groupon and other coupon sites: there are more of them than you might think.

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Benjamin Edelman and Paul Kominers have a fantastic post up about the various legal pitfalls facing Groupon and other coupon sites: there are more of them than you might think. In many states, for instance, it’s illegal to offer discounts on alcohol, yet Groupon merchants do so anyway. In others, coupons need to have a 5-year expiration, rather than the much shorter ones found on most Groupons; it’s not enough just to offer the consumer’s money back for that long. Elsewhere, people redeeming coupons for less than the face value are required to get the difference back in cash. And it’s also quite common for merchants to need to hand over to the state any money they got from expired coupons.

And then there’s the question of sales tax. Let’s say I spend $20 for a $40-face-value Groupon at a restaurant. I rack up a $60 bill, before tax and tip, and the check arrives, charging me $65.32 after adding 8.875% sales tax. I hand over a Groupon and a credit card, and my card gets charged the difference, of $25.32; I then add a tip on the $60 amount. So far so normal.

But in fact, once I hand over the Groupon, the sales tax should be recalculated — this according to unanimous advice from various state authorities. Rather than charging tax on $60, the tax should be calculated only on the post-coupon amount of $20, and the check total should be $21.77.

This is in fact the amount of tax the restaurant pays — when doing its taxes, the restaurant adds up its cash receipts and calculates the total tax due. It doesn’t include coupons. So the extra tax — in this case $3.55, or 8.875% of $40 — is essentially a hidden gift which goes directly to the restaurant. (But not to the server! So don’t use this as an excuse to tip less!)

(Update: This gets complicated, I think I got this wrong. The restaurant should actually charge sales tax on the post-coupon amount plus the amount that the customer paid for the coupon. So in this case that would be $20 plus $20 makes $40. The restaurant is still charging too much sales tax, but only $1.77, or 8.875% of $20.)

Those sales-tax amounts quickly add up:

We value the principles of consumer protection law, and we hesitate to discard rights consumers have fought for years to obtain. Furthermore, the amounts at issue are substantial: Groupon’s S-1 anticipates selling $2 billion of vouchers in 2011. An extra 7% tax on that amount would be $140 million taken from consumers, and 15% nonredemption would cost a further $300 million.

The big picture here is that Groupon and other coupon sites are being unreasonably aggressive in trying to slough off legal responsibility for these issues onto their merchants. This bit is worth quoting at length:

Voucher services typically seek to cast themselves as mere marketing vendors that are not responsible for the conduct of the corresponding merchants. For example, Groupon’s Terms of Sale claim that “The Merchant, not Groupon, is the seller of the Voucher and the goods and services and is solely responsible for redeeming any Voucher you purchase.” On this view, a voucher service avoids liability for merchants’ shortfalls.

But a voucher service is the merchant of record for the charge to the customer’s credit card. As the entity officially responsible for charging the consumer, the voucher service thus faces increased responsibility to see that the consumer receives what was promised. Furthermore, the voucher service, not the merchant, writes the promotional text touting the merchant’s offering. As Rakesh Agrawal points out, Groupon’s financial disclosures even count the entirety of the consumer’s purchase price as revenue to Groupon. In this context, a consumer naturally looks to a voucher service for assistance if a merchant fails to perform. We think it is probably an unfair and deceptive practice, under the FTC Act and state equivalents, for voucher vendors to attempt to disclaim liability in such circumstances.

More generally, we are struck by Groupon’s attempts to push all responsibility to merchants. On every relevant question — discounting alcohol, honoring expiration dates, providing cashback — Groupon’s historic contract and current Merchant Terms of Service claim merchants are responsible. In our view, this approach invites confusion and non-compliance. Voucher services are far better positioned than merchants to determine what the legal system requires: Voucher services can research regulations centrally, once for each state in which they operate, then notify affiliated merchants of applicable requirements. In contrast, Groupon’s current approach asks each individual merchant to conduct its own research. If merchants actually conducted such research, it would be duplicative and potentially wasteful — thousands of small businesses re-researching the same questions. But in fact merchants typically ignore the questions, rationally concluding that these questions are too difficult for them to address on their own. Thus, by pushing merchants do to the work individually, voucher services virtually assure that the work is not done at all.

Importantly, the legal and regulatory questions flagged in this article are questions that arise distinctively in the context of discount vouchers: a merchant would never confront such questions were it not for discount vouchers. Having created the transactions giving rise to this regulatory complexity, we think discount voucher services should be expected to achieve compliance.

Andrew Mason, Groupon’s CEO, is the smiling face of customer service which exceeds expectations and keeps everybody — customers and merchants alike — happy. So it’s worrying to me that he’s set up his company in such a manner as to make it seem that these important legal issues are not his problem. Groupon is swimming in money these days: it should spend some of its millions on some decent lawyers and set a high standard in such areas for copycat sites to match. Otherwise its much-vaunted customer service looks as though it’s entirely cosmetic, and serves to disguise the fact that Groupon is helping merchants flout consumer-protection laws across the country.

7 comments

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Eh. These “important legal issues” are largely unsettled (and would vary from state to state, if not municipality to municipality), and companies like Restaurant.com have operated in this gray area for a long time. It’s not surprising that Groupon does its best to push the responsibilities onto the local business, since the alternative is impossible to articulate (“spend some of its millions on decent lawyers” sounds like a great way to lose millions with no positive outcome). I’d leave the speculation here to lawyers and accountants, and take even their advice with a grain of salt until there’s actually an AG investigation or verdict/settlement.

Some of this stuff is so minor as to be laughable. Do you really that this particular sales tax leakage from restaurants comprises even a small fraction of their tax evasion? Restaurants probably screw this up (on purpose) just like they intentionally screw up gift certificate taxation (not to mention cash transaction reporting…).

Posted by absinthe | Report as abusive

“I’d leave the speculation here to lawyers and accountants, and take even their advice with a grain of salt until there’s actually an AG investigation or verdict/settlement.”

This is the kind of sentiment that keeps class action plaintiff’s lawyers in business.

Posted by AnonymousChef | Report as abusive

Felix, you say that Groupon is swimming in money these days”, but they are losing money hand over fist.

The more I learn about Groupon, the more I lose respect for Google. Did they really offer $5 billion for this company?

Posted by KenG_CA | Report as abusive

> Voucher services are far better positioned than merchants to determine what the legal system requires: Voucher services can research regulations centrally, once for each state in which they operate, then notify affiliated merchants of applicable requirements.

I would think it would be the other way around; a merchant who sells wine in a state that forbids discounting wine might well already know that, while someone like Groupon would simply never guess that a state might do that. Am I incorrect as to local small business knowledge of relevant law?

Posted by dWj | Report as abusive

@AnonymousChef : No, it’s the kind of sentiment that prevents people from conflating accounting standards, legal obligations, and business practices. Pick one of the three and maybe you can argue clearly about it. Mix all three into one post and you can’t say anything of substance.

Your comment is even more confusing since this blog post advocates shifting of responsibility onto the only entity that’s capable of being a class action target.

Posted by absinthe | Report as abusive

Your comment on the tax sitation is on the face of it implausible, and seems to be a misreading of the sourced document anyway.

In your example, you claim that tax should be on the post coupon amount only ($20, even though you also paid $20 for the groupon, so you actually spent $40). Suppose I get a gr/coupon for $X and spend exactly $X _at the restaurant_ (so I pay $0 extra on the spot). Do you claim that I own no sales tax? This seems like an obvious and unlikely hole in the tax laws if true. (I’d expect a lot of “no discount at all” groupons if this were the case, since they would still allow the diner to avoid tax).

Now I only read far enough into the Edelmen/Kolmers report to get to the first tax authority cited: an opinion from the Massachusetts Department of Revenue. It seems totally clear: tax is due on “the amount the consumer actually pays” and in their example this absolutely includes what they paid for the groupon (in their example, there was no over-spending beyond the group-on face value anyway). Based on this, surely Massachetts expects tax not on the full 60, nor on 20, but on the $40 the diner actually paid!

Posted by bxg07 | Report as abusive

There are other issues that seem to go unaddressed by Groupon or Living Social. For instance a merchant agrees to run the Groupon for a service that often must be done at cost or below cost with the hopes of attracting more business. Is the merchant allowed to write off any of their costs as advertising? Highly unlikely although it would be much simpler if these sites could provide better guidance on just how taxation should be applied, but instead its most about getting the credit card payment and securing the money until that 60 days has passed. Its most likely the merchant is most vulnerable when it comes state departments of revenue and the IRS.

Posted by kells1001 | Report as abusive