On August 22, 2016, the IRS released Revenue Procedure 2016-44 (the “Revenue Procedure”), which liberalized in some respects the IRS’s approach towards so-called “management contracts” as they relate to projects financed with proceeds of tax-exempt obligations (“Financed Projects”). The Revenue Procedure applies to projects financed with proceeds of governmental and qualified 501(c)(3) tax-exempt obligations (“Bonds”).
The Federal Tax Code and related Treasury Regulations prohibit governmental issuers and 501(c)(3) borrowers (“Qualified Users”) from entering into management or service contracts where the service provider’s compensation is based, in whole or in part, on a share of the net profits derived from operating Financed Projects. Historically, Qualified Users applied the safe harbors, rules and exceptions set forth in Revenue Procedure 97-13 to determine whether a management contract resulted in a share of net profits that would cause “private business use” of Financed Projects and potentially jeopardize the tax-exempt status of Bonds.
The safe harbors that outlined permitted management contracts in Revenue Procedure 97-13 were largely formulaic and depended on combinations of the length of the contract, termination provisions, and compensation arrangements. These restrictions were made more flexible with the release of IRS Notice 2014-67, which generally permits a variety of compensation arrangements, so long as the compensation is not based on a share of the net profits derived from Financed Projects and the term of the contract does not exceed 5 years.
The Revenue Procedure continues this trend of taking a more flexible and less formulaic approach toward management contracts by outlining two new safe harbors. The primary safe harbor is met (and, therefore, the contract will not result in private business use) if:
• the service provider receives reasonable compensation not based on a share of net profits;
• the service provider does not bear any net losses from the operation of the managed property;
• the term of the contract is not greater than the lesser of 30 years or 80% of the economic life of the managed property;
• the Qualified User exercises a significant degree of control over the use of, and bears the risk of loss with respect to, to the managed property;
• the service provider does not receive the benefit of any tax attributes of the managed property (depreciation, tax credits, etc.); and
• the service provider does not have any role or relationship with the Qualified User that substantially limits the Qualified User’s ability to exercise its rights under the contract.
Alternatively, another safe harbor in the Revenue Procedure is met (and, therefore, the contract will not result in private business use) if the only compensation under the contract consists of reimbursement of actual expenses paid by the service provider to unrelated parties and reasonable related administrative overhead expenses of the service provider.
The safe harbors contained in the Revenue Procedure apply to any management contract with a service provider entered into on or after August 22, 2016 and may be applied to contracts entered into prior to this date. Qualified Users may continue to apply the Revenue Procedure 97-13 safe harbors (as amplified by Notice 2014-67) to any management contract entered into before February 18, 2017. Presumably, after this date, only the rules, definitions and safe harbors outlined in the Revenue Procedure will apply to determine whether management contracts result in private business use of Financed Projects.
A copy of Revenue Procedure 2016-44 can be found here.
Posted: Aug 25, 2016