WASHINGTON – The National Association of Bond Lawyers wants the Treasury Department and Internal Revenue Service to revise the management contract guidance released in August, which it says is confusing and could limit the usefulness of safe harbors in short-term contacts.
In a five-page comment letter sent to Treasury Associate Tax Legislative Counsel John Cross and IRS Office of the Chief Counsel Branch Chief Vicki Tsilas, NABL President Cliff Gerber said that the guidance in Rev. Proc. 2016-44 creates "interpretative gaps" that could limit the usefulness of the safe harbor guidance and may be inconsistently applied by IRS examiners of management contract private business use rules.
"NABL is concerned … that certain aspects of the safe harbors could cause confusion among issuers, borrowers, their counsel, and Internal Revenue Service examiners and would limit the usefulness of the safe harbors, particularly with respect to shorter-term contracts," Gerber wrote.
The guidance took effect for any management contract entered into on or after Aug. 22 of this year. But issuers can apply the safe harbors in Rev. Proc. 97-13 to any contract entered into before Aug. 18, 2017 as long as it's not materially modified.
NABL said that management and service contract safe harbors are relied upon by a large number of issuers, including those that finance public infrastructure projects through bond issuances. For that reason, NABL stressed the importance of having clear, clarified safe harbors.
"It's making sure there is clarity not only for borrowers but also for IRS examiners," Bill Daly, director of governmental affairs for NABL, told The Bond Buyer. "We want to avoid an unnecessary expenditure of resources on the part of the IRS and on the part of borrowers."
The new safe harbors, under which a management contract does not result in private business use, allows for more incentive compensation and encourages use in funding bond-financed infrastructure projects and public-private partnerships. Rev. Proc. 2016-44 extends the terms of long-term management contacts to up to 30 years from the previous 15-year limit and removes the formulaic fixed fee requirements for manager compensation. It also contains three new provisions containing limits that ensure no private ownership or leases.
It modifies and supersedes Rev. Proc. 97-13, which established safe harbors under which a contract of up to 10 years would require at least 80% of the manager's annual compensation to be based on a fixed fee, and at least 95% of annual compensation for fifteen-year contracts based on a fixed fee.
Although NABL said it appreciated Treasury and IRS efforts to make management contracts more flexible and less formulaic, the group outlined six points of concern within the guidance that it believes should be revised or clarified.
First, NABL said it is concerned that IRS auditors may assert that a management contract creates private business use if the contract falls outside of the safe harbor conditions of the revenue procedure, a risk that it said impairs its flexibility.
"For that reason, we believe an express statement by the Treasury Department is needed to communicate that the revenue procedure does not alter the interpretations, policies, and concepts that were addressed by Rev. Proc. 97-13," the group wrote.
Second, NABL said that the new less formulaic approach creates uncertainty as to whether compensation arrangements benefit form a safe harbor against private business use. It called for two clarifying statements on periodic fixed fees, capitation fees, per-unit fees, and percentages of revenues or expenses. One would state that they will not be considered to be based on a share of net profits regardless of whether the expenses incurred by the service provider are reimbursed. The other would clarify they will not be considered to be based on a share of net profits regardless of the operating expenses borne by the service provider.
NABL also called for a statement that separate billing arrangements by physicians be treated as per-unit arrangements.
Notice 2014-67, released by the IRS in 2015, stated that a management contract would not result in private business use if it is five years or less and compensation is based on a stated amount, periodic fixed fee, capitation fee, per-unit fee or any combination.
Next, NABL asked for additional clarification that the qualified user can approve rates charged for use of the managed property by either approving the rates or by including in the contract a requirement that a third party determined appropriate rates charged by the service provider.
"We understand the underlying reason for imposing a rate control test but believe that additional guidance is critical to avoid inconsistent application," the group wrote.
To avoid any uncertainty, NABL asked for a clarification that the determination of economic life be based on facts at the time of determination, which it believes is the intent of the safe harbor.
The group also asked for a clarification that the economic life of the managed property is to be determined on a weighted average basis regardless of the source of financing, which it said better reflects the scope of the assets and facilities managed.
NABL said it is "seriously concerned" that the revenue procedure excludes land from the calculation of economic life, and asked that land be treated in all instances of having an economic life of 30 years.
One of NABL's more pointed comments is about the 80% economic life test in the new revenue procedure, which it said could create a significant burden for short-term contracts.
The economic life test states that the maximum term of a management contract under the safe harbors may not exceed 80% of the economic life of the managed property. “For long-term contracts relating to assets that have long lives, this test may not seem to be a problem,” said Matthias Edrich, a tax partner at Kutak Rock in Denver, “but for managed assets with particularly short lives, the restriction may well be unworkable. Assume, for example, that the contract relates to managed property that has a remaining life of five years (perhaps because it is a building that will be torn down in five years). The 80% requirement would effectively prohibit a management contract in the last year of the property’s life.”
Rev. Proc. 2016-44 effectively says that no management contract is permitted for the last year without requiring the qualified user and service provider to enter into multiple management contracts, both limited to 80% of the remaining economic life at the time of the contract.
"This result poses significant practical and administrative difficulties that are unwarranted," NABL said.
This differs from Rev. Proc. 97-13, which permits contracts with up to five-year terms without regard to the economic life of the managed property that do not provide for the sharing of profits.
NABL requested the guidance be revised to exclude contracts of five or fewer years from the 80% economic life test.
Lastly, the group said that current references to the timing of compensation "cast uncertainty" over the use of certain deferred compensation provisions that it believes do not violate the revenue procedure. NABL requested Treasury and the IRS clarify that a deferral of compensation will not create a net profits arrangement or cause a service provider to bear net losses if the contract provides that any deferral is subject to an interest charge or other penalty and all compensation is scheduled to be paid prior to the end of the contract term.
After its release, Rev. Proc. 2016-44 was praised by bond lawyers, who appreciated the more liberal safe harbors and Treasury and IRS' concerns in how to make existing less restrictive.
But that praise was short-lived, as several bond attorneys began expressing questions or concerns, including whether the term of a contract is retested when one is modified or a new contract is entered into. In their letter, NABL officials also expressed concern that IRS officials may also experience similar confusion.
"Clarification …. will also assist in educating and training Internal Revenue Service examiners concerns the appropriate interpretation of the revenue procedure," NABL officials said.
The comments were put together by 14 NABL working group members and approved by NABL's Board of Directors.