On January 22, 2015, the National Association of Bond Lawyers submitted comments on Notice 2014-67 to the IRS. For those of you who like acronyms and defined terms, we’ll call these the “NABL” “Comments” on the “Notice”, and we’ll let you guess what “IRS” stands for.

The first part of the Comments focuses on Accountable Care Organizations (“ACO”), specifically on the “ACO Safe Harbor” of section 3.01 of the Notice, and the second part addresses the newfive-year safe harbor from private business use for management contracts added to Revenue Procedure 97-13 (the “Management Contract Safe Harbor”).

ACO Safe Harbor

The Comments request clarification that the ACO Safe Harbor is actually a safe harbor for determining whether participation by a qualified user of bond-financed property in an ACO results in private business use of that property, and they also request clarification that the ACO Safe Harbor does not displace the general facts and circumstances test provided by other authorities to determine whether an arrangement results in private business use.

The Comments express concern that the scope of the ACO Safe Harbor is too narrow, because it focuses only on ACO arrangements accepted into the Medicare Shared Savings Program, which are a minority of ACO or value-based healthcare arrangements.  In addition to the limited applicability of the ACO Safe Harbor, the Comments raise a concern that the term “participation,” as used in this Safe Harbor, could be interpreted to suggest that private business use could arise from certain contractual agreements between an ACO and a physician group even if those agreements are in full compliance with Rev. Proc. 97-13. This concern arises because, under the healthcare regulations, the term “ACO Participant” includes physician groups that provide services to the ACO, even if the physician group has neither an ownership nor a management interest in the ACO.  Thus, if the ACO Safe Harbor’s use of “participation” is similarly broad, a possible interpretation of the ACO Safe Harbor is that arrangements between an ACO and a physician group result in private business use of bond-financed facilities, even if that arrangement satisfies Rev. Proc. 97-13, unless the physician group  is a 501(c)(3) organization or, less likely, a state or local governmental entity and is therefore not a nongovernmental participant in the ACO.

The Comments also request confirmation of, clarification of, or alterations to, specific prongs of the ACO Safe Harbor. First, the Comments request that that the “written agreement” prong be modified to require only that the methodology of the allocation of a shared savings payment, rather than the specific amount of the payment, be agreed to in advance. Second, the Comments request that the proportionality and equivalence prongs be clarified to provide that the determination of the share of the ACO’s economic benefits to be received by a  qualified user of bond-finance property may be separate from the determination of the share of ACO losses allocated to that user and may also be separate from the determination of the proportion of any ACO ownership interest received by the qualified user  and the qualified user’s return of capital, allocations, and distributions from the ACO. The Comments note that these prongs are not flexible enough to address ACOs that are structured to provide only sharing of “upside” with no sharing of losses. Third, the Comments suggest that the fair market value prong of the Safe Harbor be modified to provide that contracts and transactions involving the ACO be negotiated at arm’s length, rather than satisfy an unspecified fair market value standard, because of the difficulty of (i) determining fair market value when there is no established market for shared savings arrangements, (ii) documenting satisfaction of a fair market value standard, and (iii) opining on this matter. Finally, the Comments request clarification that the limitations on transfer prong of the Safe Harbor does not bar a qualified user of bond-financed property from (i) allowing an ACO to use that property pursuant to a qualified management contract (or other arrangement that does not result in private business use) or (ii) leasing that property to an ACO within the limits of the private business use and private payment tests.

Management Contract Safe Harbor

NABL addresses two of the Comments to the Management Contract Safe Harbor, which NABL observes (as did we) applies to all tax-exempt bond borrowers, not just healthcare borrowers.  First, the Comments recommend that Rev. Proc. 97-13 or the Notice be amended to include a definition of “stated amount.”  A stated amount is one compensation alternative available under the Management Contract Safe Harbor, but it is the only one that is not presently defined in either Rev. Proc. 97-13 or the Notice.

Second, the Comments make a suggestion similar to our prior suggestion that permissible incentive compensation under the Management Contract Safe Harbor include not only incentives available upon satisfaction of qualitative criteria, but also incentives available when specified levels of gross revenues or adjusted gross revenues are exceeded or specified levels of expenses are observed (but not incentives that are based on both revenues and expenses).  This Comment, like the others, is an excellent recommendation.  Qualitative measures, which are allowed under the Management Contract Safe Harbor, are a proxy for the quantitative effects of either enhanced revenue or decreased expenses, because the objective of these qualitative measures instill procedures that achieve these quantitative effects.  Thus, it’s difficult to think of a persuasive rationale for allowing incentive compensation that’s based on qualitative criteria, but not on revenue enhancement or cost reduction.