Facility Mangement Contracts - PDF

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					                        QUALIFIED MANAGEMENT CONTRACTS

        The Income Tax Regulations, in section 1.141-3(b)(4), set forth the rules regarding
“qualified management contracts” for property financed with the proceeds of tax-exempt
“governmental bonds.” In addition, at the same time as the release of these regulations in 1997,
the IRS released Revenue Procedure 97-13, which contains many of the substantive rules that
had been set forth in earlier proposed regulations. Subsequently, on July 9, 2001, the IRS
released Revenue Procedure 2001-39 modifying its definitions of “capitation fee” and “per-unit
fee” to permit automatic increase of such fees if the increase is based on objective standards not
linked to the output or efficiency of a facility (e.g., increase based on the Consumer Price Index).

        The Income Tax Regulations provide that management contracts (or other service
contracts) entered into with respect to financed property may result in private business use.
However, if the rules set forth in the Income Tax Regulations and Revenue Procedures 97-13 and
2001-39 are followed, any resulting management contract will not result in private business use.
In addition, functionally related and subordinate property used pursuant to a qualifying
management contract does not give rise to private business use (e.g., exclusive use of storage
areas by a manager for its equipment necessary under a qualifying management contract is not
private use as long as the use does not in substance give rise to the level of a separate contractual
arrangement).

        Under the Income Tax Regulations, a management contract is a management, service, or
incentive payment contract between a governmental person and a service provider under which
the service provider provides services involving all, a portion of, or any function of, a facility.
For example, a contract for the provision of management services for an entire hospital, a
contract for management services for a specific department of a hospital, and an incentive
payment contract for physician services to patients of a hospital are each treated as a
management contract. The Income Tax Regulations and the Revenue Procedures also apply to
determine whether obligations issued by qualified 501(c)(3) organizations for their exempt
purposes meet the tests applicable to such financings.

        Generally, a management contract will result in private business use if the contract
provides for compensation for services rendered based, in whole or in part, on a share of net
profits from the operation of the financed facility. In addition, unless one of the exceptions to
private business use applies, the contract will result in private use if the provider is treated as the
lessee or owner of the financed property for federal tax purposes. If the compensation
arrangements of a management contract are materially revised, the new arrangements are
retested as of the date of the material revision and the contract is treated as a new contract on the
date of the material revision for purposes of applying the Income Tax Regulations and the
Revenue Procedures.

      The Income Tax Regulations specifically provide that certain contracts are not treated as
management contracts that give rise to private business use. These include:

                 (a)   contracts for incidental services at the financed facility (e.g., janitorial,
         office equipment repair, hospital billing or similar services);




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                (b)      the mere granting of admitting privileges by a hospital to a doctor even if
         those privileges are conditioned on the provision of de minimis services, if those services
         are available to all qualified physicians in the area, consistent with the size and nature of
         the facilities (incentive payment contracts for physicians are treated as management
         contracts);

                (c)     a contract to operate public utility property if the only compensation is the
         reimbursement of actual and direct expenses of the service provider and its reasonable
         administrative overhead; or

                 (d)    a service contract if the only compensation is the reimbursement of the
         service provider for actual and direct expenses paid to unrelated parties.

        Compensation Requirements. As noted above, the contract must provide for reasonable
compensation for services with no compensation based on a share of net profits from the
operation of the facility. The service provider may be reimbursed for actual and direct expenses
without it being treated as compensation. Any one of the following is generally not considered
to be based on a share of net profits:

                (a)     a percentage of gross revenues (or adjusted gross revenues, which is gross
         revenues less bad debt and contractual or similar allowances) of a facility or a percentage
         of expenses from a facility, but not both;

                (b)     a capitation fee; or

                (c)     a per-unit fee.

       In addition, a productivity award equal to a stated amount of increase or decrease in gross
revenues (or adjusted gross revenues) or expense reductions, but not both, does not cause the
compensation to be based on a share of net profits.

        A capitation fee is a fixed, periodic amount for each person for whom the service
provider assumes the responsibility to provide all needed services for a term so long as the
quantity and type of services actually provided vary substantially. A capitation fee may include
a variable component of up to 20% of the total capitation fee designed to protect the provider
against risks such as catastrophic loss. A common example of a capitation fee is an amount paid
to a health maintenance organization.

       A per-unit fee is a fee based on a unit of service provided in the contract or specifically
determined by a third party such as the Medicare administrator or the issuer. Examples of a
per-unit fee include a stated dollar amount for each medical procedure performed, car parked or
passenger mile. Separate billing arrangements between hospitals and physicians are treated as
per-unit fee arrangements.

       Terms. The following types of contracts are permissible under Revenue Procedures
97-13 and 2001-39:




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                (a)     A contract in which at least 95% of the annual compensation is based on a
         periodic fixed fee and the term of the contract, including all renewal options, does not
         exceed the lesser of 80% of the reasonably expected economic life of the financed
         property or 15 years.

                (b)     A contract in which at least 80% of the annual compensation is based on a
         periodic fixed fee and the term of the contract, including all renewal options, does not
         exceed the lesser of 80% of the reasonably expected economic life of the financed
         property or 10 years.

                A periodic fixed fee is a stated dollar amount for services rendered for a set
         amount of time. Capitation and per-unit fees are not periodic fixed fees. The fees may
         automatically increase according to a specified, external standard such as the Consumer
         Price Index. A fee does not fail to be a periodic fixed fee under (a) and (b) if it
         automatically increases as a result of a one-time incentive award during the term of the
         contract when a gross revenue or expense target (but not both) is reached. That award
         must be equal to a single, stated dollar amount.

                A contract contains a renewal option if the service provider has a legally
         enforceable right to renew the contract. A provision under which a contract is
         automatically renewed absent cancellation by either party is not a renewal option even if
         the contract is expected to be renewed.

                 If all of the financed property is public utility property, then the 15- and 10-year
         limitations of (a) and (b) above are 20 years.

                 (c)     A contract in which at least 50% of the annual compensation is based on a
         periodic fixed fee, or all of the compensation is based on a capitation fee or a
         combination of a capitation fee and a periodic fixed fee and the contract term plus all
         renewal options does not exceed five years. The contract must be terminable by the
         governmental unit or 501(c)(3) organization on reasonable notice, without penalty or
         cause, at the end of the third year.

                 Examples of penalties for terminating a contract include limits on the
         governmental unit or 501(c)(3)’s rights to compete with the service provider, a
         requirement that they purchase equipment, goods or services from the service provider
         and a requirement that they pay liquidated damages for cancellation of the contract. In
         contrast, a contract may, on termination, require the issuer to reimburse the service
         provider for ordinary and necessary expenses or may restrict the issuer from hiring key
         personnel of the service provider. A second contract between the parties such as a loan
         or guarantee by the service provider may be considered a contract termination penalty if
         it contains noncustomary or non-arm’s-length terms that could operate to prevent
         termination of the service or management contract (e.g., provisions under which a loan is
         called if the management contract is terminated or that places substantial restrictions on
         the selection of a substitute service provider).




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                (d)     A contract in which all of the compensation is based on a per-unit fee or a
         combination of a per-unit fee and a periodic fixed fee and the term, including renewals,
         does not exceed three years. The contract must be terminable by the governmental unit
         or 501(c)(3) organization on reasonable notice, without penalty or cause, at the end of the
         second year.

                  (e)     A contract in which all of the compensation is based on a percentage of
         fees charged or a combination of a per-unit and a percentage of revenue or expense fee
         and the term of the contract including renewal options does not exceed two years. The
         contract must be terminable by the governmental unit or 501(c)(3) organization on
         reasonable notice, without penalty or cause, at the end of the first year. This type of
         contract may be utilized only where the service provider provides service to third parties
         (e.g., radiology services to patients) and management contracts involving a facility during
         an initial start-up period for which there have been insufficient operations to establish a
         reasonable estimate of the amount of the annual gross revenues and expenses.

        Control of the Manager or Service Provider. The service provider must not have any
role or relationship with the governmental unit or 501(c)(3) that limits the governmental unit’s or
501(c)(3)’s ability to exercise rights, including cancellation rights. Revenue Procedure 97-13
provides a safe harbor rule for determining if this rule has been violated. The safe harbor states
that the rule will not be violated if not more than 20% of the voting power of the governing body
of the governmental unit or 501(c)(3) in the aggregate is vested in the service provider and its
directors, officers, shareholders and employees. For this purpose, overlapping board members
may not include the chief executive officers of the service provider or its governing body or the
governmental unit or 501(c)(3) or its governing body. Finally, the governmental unit or
501(c)(3) and the service provider may not be related parties under the Internal Revenue Code.

                                                                                September 3, 2002




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