On August 22, the Internal Revenue Service released Revenue Procedure 2016-44, which changes the management contract safe harbors contained in Revenue Procedure 97-13 regarding private business use.

Rev. Proc. 2016-44 went into effect immediately and applies to management contracts entered into on or after August 22. However, issuers and borrowers may apply the prior safe harbors set forth in Rev. Proc. 97-13 to any contract entered into before August 18, 2017, so long as the terms of the contract are not materially amended or modified on or after August 18, 2017.

Rev. Proc. 2016-44 creates a safe harbor for management contracts of up to 30 years in duration when such arrangements meet the criteria set forth in Rev. Proc. 2016-44. It also eliminates the various formulaic approaches to compensation contained in Rev. Proc. 97-13. This expanded safe harbor may allow entities that finance property through tax-exempt bonds, such as non-profit hospitals and healthcare systems, to negotiate management contracts that better effectuate the business goals of the contracting parties.

More specifically, the safe harbor available under Rev. Proc. 2016-44 provides eight specific conditions under which a management contract involving managed property that is financed through tax-exempt bonds will not result in prohibited private business use. The eight conditions are:

  1. the payments to the service provider under the contract must be reasonable compensation for services rendered during the term of the contract;
  2. the contract must not provide to the service provider a share of net profits from the operation of the managed property;
  3. the contract must not, in substance, impose upon the service provider the burden of bearing any share of net losses from the operation of the managed property;
  4. the term of the contract, including all renewal options, is no greater than the lesser (a) of 30 years or (b) 80% of the weighted average reasonably expected economic life of the managed property;
  5. the hospital must exercise a significant degree of control over the use of the managed property;
  6. the hospital must bear the risk of loss upon damage or destruction of the managed property;
  7. the service provider must agree that it is not entitled to and will not take any tax position that is inconsistent with being a service provider to the hospital with respect to the managed property; and
  8. the service provider must not have any role or relationship with the hospital that, in effect, substantially limits the hospital’s ability to exercise its rights under the contract.

Additionally, (1) management contracts that qualify as “eligible expense reimbursement arrangements” (such that the only compensation under the contract is composed of “reimbursements of actual and direct expenses paid by the service provider to unrelated parties and reasonable related overhead expenses”) and (2) use of the managed property that is “functionally related and subordinate to a management contract that meets” the eight above-listed conditions, do not result in private business use.