United States: IRS Expands Management Contract Guidelines For Projects Financed With Tax-Exempt Bonds

Edward Rojas is Senior Counsel for Holland and Knight's New York office.


  • The Internal Revenue Service (IRS) earlier this year released Rev. Proc. 2017-13 (the Guidelines), which contained new safe harbors for qualified management contracts relating to facilities financed with tax-exempt bonds.
  • If a management contract satisfies the safe harbors under the new Guidelines, it will not result in "private use" of the financed facility.
  • The Guidelines apply to management contracts entered into on or after Jan. 17, 2017, but an issuer may elect to apply them to prior contracts. However, because prior IRS revenue procedures were superseded by the Guidelines, the prior IRS procedures can be applied only to contracts entered before Aug. 18, 2017, and that are not materially modified or extended after that date.

The Internal Revenue Service (IRS) earlier this year released Rev. Proc. 2017-13 (the Guidelines), which contained new safe harbors for qualified management contracts relating to facilities financed with tax-exempt bonds. The Guidelines were released to supersede and amend the prior Rev. Proc. 2016-44 (the "Prior Guidelines"), which built on, expanded upon and superseded prior safe harbors for management contracts set forth by the IRS and provided much greater flexibility in the structuring of these contracts. If a management contract satisfies the safe harbors under the new Guidelines, it will not result in "private use" of the financed facility. The Guidelines resolve ambiguities in the Prior Guidelines.


The IRS previously issued safe harbors for management contracts set forth in Rev. Proc. 97-13 and Rev. Proc. 2001-39 (the Prior Procedures). The Prior Procedures generally provided that management contracts would not result in private business use of bond-financed facilities depending on the term of the contract and the method of compensation. For example, under the Prior Procedures, a qualified management contract in which 95 percent of the compensation was based on a fixed fee could have a maximum term of 15 years, while a qualified management contract with compensation based only 50 percent on a fixed fee was limited to a five-year term. Over the years, the IRS has issued private letter rulings that expanded these safe harbors, and in 2014 issued Notice 2014-67 that amplified the Prior Procedures to allow much greater flexibility in the use of variable compensation and incentive arrangements for contracts having a term up to five years, as well as to allow certain uses relating to accountable care organizations.

Continuation of Prior Requirements

The Guidelines continue many of the requirements set forth in the Prior Procedures, such that the manager's compensation must be reasonable and that none of the manager's compensation may be based on a share of the net profits of the managed property. Similar to the Prior Procedures, none of the manager's compensation may be based upon, or contingent upon, both the managed property's revenues and expenses for any fiscal period.

30-Year/80 Percent Useful Life Contracts Permissible Under Guidelines

The Guidelines permit qualified management contracts to have a maximum term (including legally enforceable renewal options) not exceeding the lesser of 30 years or 80 percent of the weighted average economic life of the portion of the "project" subject to the management contract. Economic life is determined as of the beginning of the contract, and is retested as a new contract as of the date any of its terms that could affect its status as a qualified contract are materially modified.

Definition of "project": It is important to note that especially for purposes of the useful life test, "project" is not limited to the facilities that are bond financed. A "project" is defined to mean "all facilities or capital projects financed in whole or in part with proceeds of a single issue of bonds." In its bond documents, an issuer can identify as a single project all of the properties to be financed by proceeds of a single bond issue. Thus, if bond proceeds are used to finance short-lived equipment (e.g., eight years or less) that is part of a building project that in total has a useful life of 40 years and the entire building is subject to the management contract, then the management contract may have a term of 30 years and is not limited to 80 percent of the useful life of the financed equipment (six years). This can also be helpful if only the land relating to a larger project is bond-financed.

Treatment of Land: Under the Guidelines, land is treated as having an economic life of 30 years if 25 percent or more of the net proceeds of the issue that finances the managed property is used to finance the cost of such land. Otherwise, the land is disregarded for purposes of calculating the economic life of the managed property. Under the Prior Guidelines, land was always disregarded.

Manager's Compensation Very Flexible But Reasonable and Not Based on Net Profits or Bearing any Net Losses

The manager's compensation may be based on any type of fixed or variable compensation that is reasonable compensation for the services provided (such compensation may also include a percentage of gross revenues – or adjusted gross revenues – of the facility or a percentage of expenses of the facility, but not both revenues and expenses). However, it may not be based or be contingent upon the net profits of the facility (which is the same as under the Prior Procedures) or result in the manager bearing any share of the net losses of the project (a new requirement). Under the Guidelines, permissible compensation arrangements are expanded to include capitation fee, per-unit fee and periodic fixed fee arrangements (described below), as well as incentive compensation arrangements (such as those often offered to physicians) based upon meeting standards that measure quality of services, performance or productivity (incentive fees). In addition, the manager may pay the unreimbursed expenses of the managed property in connection with capitation fee, per-unit fee, periodic fixed fee, incentive fees or any combination thereof, and this will not result in a net profits arrangement or the bearing of net losses. Reasonable compensation also applies to the reimbursement of actual and direct expenses paid by the manager and related administrative overhead expenses.

Capitation fee: A fixed-dollar amount is paid for each person for whom the provider agrees to provide all needed services for a period of time, such as when an HMO agrees to provide all medical services to a patient. The fixed fee can be increased by specific, objective, external standards not linked to the output or efficiency of the managed property, such as the Consumer Price Index (CPI) or industry increases. This fee may include a variable component of up to 20 percent of the fee to protect the provider against catastrophic loss.

Per-Unit Fee: This fee is based upon a unit of service by the provider specified in the contract or determined by an independent third party such as Medicare, or by the exempt entity. This includes separate fees for medical procedures, car parking or passenger miles. It also includes separate billing arrangements between physicians and hospitals. The fixed fee can be increased by specific, objective, external standards not linked to the output or efficiency of the managed property, such as CPI or industry increases.

Periodic fixed fee: This is a stated dollar amount for service rendered for a specific period of time (e.g., a stated dollar amount per year). The fixed fee can be increased by specific, objective, external standards not linked to the output or efficiency of the managed property, such as CPI or industry increases.

Definition of Net Profits: A management contract is based upon a managed facility's "net profits" if it is based in any part on both the facility's revenues and expenses for any fiscal period. This includes basing the eligibility for, the amount of and the timing of the payments under the contract upon net profits. However, in determining if compensation is based upon net profits, the reimbursement of actual and direct expenses to unrelated parties (such as unrelated vendors) is disregarded, as are incentive payments (such as those paid to physicians) for meeting certain quality standards of services, performance or productivity.

Description of Net Losses: A management contract does not require the bearing of net losses if: (i) the determination of the amount of the manager's compensation and the amount of unreimbursed expenses to be paid by the manager, separately and collectively, do not take into account either the managed property's net losses or both the managed property's revenues and expenses for any fiscal period, and (ii) the timing of the manager's compensation is not contingent upon the amount of the managed property's net losses. Thus, it is permissible to reduce a manager's compensation by stated dollar amounts if the managed property's expenses exceed certain targets, because the reduction does not also take into account any measure of the property's revenues. However, under the Prior Guidelines it was questionable whether it would be permissible to delay a manager's compensation because there were no net revenues from which to pay it. The Guidelines allow this deferral of payments due to insufficient net cash flows when the contract includes the following requirements: (i) the compensation is payable at least annually, (ii) the exempt entity is subject to reasonable consequences for late payment, such as reasonable interest charges or late payment fees, and (iii) the exempt entity will pay such deferred compensation (with interest or late payment fees) no later than the end of five years after the original due date of the payment.

Exempt Entity Must Exert Significant Control

The exempt entity must exercise significant control over the use of the managed project. This is met if the management contract requires the exempt entity to approve the annual budget of the facility, its capital expenditures, disposition of the property, rates charged for user of the facility, and the general nature and use of the property. These approvals may be shown in different manners, but they must be explicit and generally in writing. An exception applies for approval of rates that may also be determined by having the contract provide that the manager's rates be reasonable and customary as determined by an independent third party (such as a medical insurance company). The Guidelines also clarify that an exempt entity may satisfy the approval of rates requirement by approving a reasonable general description of the method used to set the rates (such as a method that establishes hotel room rates using specific revenue goals based upon comparable properties).

Exempt Entity Must Bear Risk of Loss

The exempt entity must bear the risk of loss upon damage or destruction of the managed project. (However, the maintenance of insurance is permitted, as is penalizing the manager for failing to operate the facility as required under the contract.)

No Inconsistent Tax Positions by Manager

The manager must agree that it will not take any tax position with respect to the project that is inconsistent with its being a qualified user under the Guidelines. Thus, the manager cannot take a tax position similar to an owner of the property (such as depreciation or amortization, or investment tax credits) or to a lessee of the project (such as deducting any payments on the property as rent).

Eligible Reimbursement Contracts Do Not Result in Private Use

The Guidelines make clear that management contracts under which the only compensation consists of the reimbursement of actual and direct expenses paid by the manager to unrelated parties and reasonable related administrative expenses do not result in private use. This is again similar to the Prior Procedures as expanded by private letter rulings.

Limitations in Governance

The Guidelines contain limitations on the governing structure of the manager that are similar to those in the Prior Procedures. The manager must not have any role or relationship with the exempt entity that, in effect, substantially limits the exempt entity's ability to exercise its rights, including cancelation rights, under the contract, based on all the facts and circumstances. This requirement is satisfied: (a) if not more than 20 percent of the voting power of the governing body of the exempt entity in the aggregate is vested in the manager's (or any related party's) directors, officers, shareholders, partners, members and employees; (b) the governing body of the exempt entity does not include the chief executive officer (or equivalent) or the chairperson (or equivalent executive) of the manager (or a related entity); and (c) the chief executive officer (or equivalent) of the manager (or a related party) is not the chief executive officer (or equivalent) of the exempt entity or any of its related entities as defined in Section 1.150-l(b) of the Regulations (relating to being members of the same controlled group or otherwise having a relationship under which losses between the two would be disallowed).

Guidelines Do Not Cover Pre-Construction Services

The Guidelines build upon the standards set forth in prior private letter rulings to provide that a contract or portion of a contract to provide services before a project is placed in service (e.g., pre-operating services for construction design or construction management) is not treated as a "management contract" and thus is not subject to the Guidelines. This also means that the term of the pre-construction services contract is not aggregated with the remaining term of the management contract.

Exception for Functionally Related and Subordinate Use

The Guidelines provide in the same manner as the Prior Procedures that a manager's use of a project that is functionally related and subordinate to its services under a qualified management contract (e.g., use of storage areas to hold necessary equipment) does not result in private use.

Effective Dates

The Guidelines apply to any management contract entered into on or after Jan. 17, 2017, but an issuer may elect to apply them to prior contracts. However, because the Prior Procedures were superseded by the Guidelines, the Prior Procedures can be applied only to contracts entered before Aug. 18, 2017, and that are not materially modified or extended after that date (except pursuant to a legally enforceable renewal option).

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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