WASHINGTON — The Internal Revenue Service should expand its safe harbors for management contracts and provide guidance that issuers and conduit borrowers could rely on when their contracts don't meet the safe harbors, an advisory group told the IRS.
At a meeting here on Wednesday, the tax-exempt bond subcommittee of the IRS' advisory committee also recommended the agency expand training for its personnel about applying the "facts and circumstances" test to determine whether management contracts create private business use, and revise training materials for IRS agents.
The subcommittee to the IRS Advisory Committee on Tax Exempt and Government Entities presented its recommendations and report on management contracts to IRS officials at their headquarters.
The subcommittee's members for 2013-2014 were Katherine Newell, director of risk management for the New Jersey Educational Facilities Authority, Lorraine Tyson, a tax partner at Pugh, Jones & Johnson in Chicago, and Sue Painter, system director and chief investment officer/treasurer of Providence Health & Services in Seattle. For 2014-2015, Floyd Newton, a partner at King & Spalding in Atlanta, will replace Painter on the subcommittee.
Rebecca Harrigal, director of the IRS tax-exempt bond office, said the recommendations that are more like guidance will be referred to the Chief Counsel's office. She said TEB will rework its training manual in fiscal 2015 to take into account the subcommittee's recommendations.
Management contracts are a concern because they can cause bonds to become taxable if there is an excessive amount of private use and private payments.
Under federal tax law, projects financed with governmental and 501(c)(3) tax-exempt bonds generally are subject to restrictions on the amount of private-business they can have. Bonds generally are considered private-activity bonds if more than 10% of the proceeds are used for private business and more than 10% of the debt service is payable from, or secured by, a private party. The thresholds for these "private business use" and "private payment" tests are lowered to 5% when determining whether bonds issued for 501(c)(3) organizations are tax exempt.
Treasury Department regulations state that management contracts between a government or nonprofit user of tax-exempt bond financed property and a private service provider can result in private business use based on all the "facts and circumstances."
Revenue Procedure 97-13 provides some safe harbors that, when followed, ensure management contracts will not result in private business use. The safe harbors generally put limits on the length of a contracts and the methodology used to determine compensation under the contract. When a management contract does not meet one of the safe harbors, an issuer or borrower has to analyze the facts and circumstances of the contract.
In the nearly two decades since the safe harbors in Rev. Proc. 97-13 were released, there have been many legislative, regulatory, economic and business practice changes. As a result, issuers and borrowers have found it increasingly useful to implement management contracts that don't meet the safe harbors, the subcommittee's report said.
Issues relating to management contracts are notably a concern in the health care sector because of new arrangements created as a result of President Obama's health care law, the Patient Protection and Affordable Care Act. "Delay in updating guidance may inadvertently impede fulfillment of the purpose of the Affordable Care Act," the report said.
The ACA allow hospitals to enter into Accountable Care Organizations, which are health care organizations where doctors, hospitals and other providers can work together to coordinate care for Medicare patients. They can include both taxable and tax-exempt participants, including hospitals that are issuers or borrowers in muni financings. Nonprofit hospitals are concerned that participating in an ACO with a for-profit entity would result in private business use.
Also, pursuant to the ACA, the Center for Medicare and Medicaid Services has created an initiative under which it will make a single "bundled" payment to all providers of services to a patient in a single "episode of care." rather than there being separate payments to each individual service provider. But the American Hospital Association has said that it's difficult to fit bundled payment arrangements into the safe harbors, the subcommittee said.
The subcommittee wants the safe harbors to be updated "to reflect current business realities," the report said. But it also wants more guidance on how to apply the facts and circumstances test in cases where there are no safe harbors, since even updated safe harbors cannot apply to all possible arrangements.
Additionally, the subcommittee recommends that IRS personnel receive additional training about the facts and circumstances tests. The subcommittee proposed updated training materials relating to management contracts in an appendix to its report. These materials include factors that an IRS agent should consider in determining whether a management contract results in private business use. The factors are based on a subcommittee review of recent private-letter rulings.
The subcommittee said it "believes that additional training will increase efficiency in responding to private letter ruling requests, [voluntary closing agreement program] requests and examinations involving non-safe-harbor management contracts."
