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IRS Releases Notice Liberalizing Private Use Rules for Management Contracts

    Client Alerts
  • October 28, 2014

On October 24, 2014, the Internal Revenue Service (“IRS”) released Notice 2014-67 (the “Notice”), providing guidance with respect to Accountable Care Organizations and their use of tax-exempt bond financed projects.  The Notice also contained guidance that creates a new, broad safe harbor from private business use for management and service contracts.  This new safe harbor applies to all management contracts, and may be applied retroactively to existing management contracts.

Under the new safe harbor, a management or service contract pursuant to which a private party operates all or a portion of a bond financed facility will not result in private business use if: (1) compensation paid to the manager is based on a stated amount, a periodic fixed fee (an amount paid for services rendered over a period of time), a capitation fee (a fixed periodic amount for each person for whom the service provider or qualified user assumes the responsibility to provide services over a specified period), a per-unit fee (a fee based on a unit of service provided), or a combination of the preceding, and (2) the term of the contract including all renewal options does not exceed 5 years.  The compensation for services also may include a percentage of gross revenues, adjusted gross revenues, or expenses of the facility (but not both revenues and expenses).

The new safe harbor represents a dramatic liberalization of the short-term management contract safe harbors currently in place, which current safe harbors severely limit the ability to combine different forms of compensation, are more restrictive on the allowable term of the contract and require the right of the governmental entity to terminate the contract well before the end of the stated term.  For example, under the current “per-unit” safe harbor, compensation paid to the service provider must be in the form of a per-unit fee or a combination of a per-unit fee and a periodic fixed fee, the term of the contract may not exceed 3 years and the governmental entity must have the right to terminate the contract within 2 years.  Under the new safe harbor, the service provider could be paid on the basis of a combination of any of the compensation types mentioned in the previous paragraph and the term of the contract can be for up to 5 years.  Further, there is no requirement that the governmental entity have the right to terminate the contract prior to its stated term.

The Notice also provides for the ability of a governmental entity to pay the manager a productivity award in any annual period if: (1) eligibility for the productivity award is based on the quality of the services provided under the management contract (for example, the achievement of quality performance standards or meeting data reporting requirements), rather than increases in revenues or decreases in expenses of the facility, and (2) the amount of the productivity award is a stated dollar amount, a periodic fixed fee, or a tiered system of stated dollar amounts or periodic fixed fees based solely on the level of performance achieved with respect to the applicable measure.

If you have any questions regarding the Notice or how the new safe harbor or productivity award provisions might impact your particular situation, please feel free to reach out to any member of the Parker Poe Public Finance Group.