Rev. Proc. 2016-44: Greater Flexibility in IRS Safe Harbor for Management Contracts
Recently, the IRS released a safe harbor from private use of tax-exempt bond-financed facilities for management contracts that profoundly changes the safe harbors that have been in place under Rev. Proc. 97-13 for almost 20 years. Rev. Proc. 2016-44, released on August 22, 2016, significantly expands the types of management contracts that can meet the safe harbor and offers health care facilities financed with tax-exempt bonds greater flexibility and clarity when entering into management contracts.
Unlike the prior guidance, Rev. Proc. 2016-44 removes the complex formulas based upon whether compensation paid a service provider was fixed or variable given the length of the term of the contract, which were the hallmark of Rev. Proc. 97-13. Instead, Rev. Proc. 2016-44 offers a more straight forward, standards-based test. Notably, under the new safe harbor, variable compensation is allowed in long-term management contracts so long as the compensation is reasonable and certain other standards are met. This is a significant departure from the prior safe harbors.
How Can I Satisfy the New Safe Harbor?
Under 2016-44, if a management contract meets all of the following standards it does not result in private use:
- General financial requirements. The contract (a) provides only reasonable compensation, (b) does not give the service provider a share of net profits and (c) does not impose the burden of sharing of any net losses on the service provider;
- Term of contract. The contract term (including renewal options) is not longer than the lesser of 30 years or 80% of the weighted average reasonably expected economic life of managed property;
- Control over managed property. The qualified user maintains a significant degree of control over use of the managed property;
- Risk of loss of managed property. The qualified user bears risk of loss for damage or destruction of the managed property;
- Consistent tax positions. The service provider agrees not to take any tax position inconsistent with being a service provider with respect to the managed property (no depreciation, amortization, investment tax credit, or rent deduction); and
- No limitation of rights. The service provider is not in a role that substantially limits the qualified user’s ability to exercise its rights under the management agreement.
The new safe harbor takes effect immediately for management contracts entered into, or materially modified, on or after August 22, 2016, and in addition, an issuer may apply this safe harbor to any management contract entered into before August 22, 2016. During an initial transition period through August 18, 2017, issuers have the option to apply either the prior safe harbors of 97-13 or the new safe harbor to management contracts entered into, or materially modified before August 18, 2017.