The financing of a facility with tax-exempt governmental bonds or bonds benefiting the business use of a 501(c)(3) not-for-profit may occur as a result of a management contract. IRS Revenue Procedure 2016-44 issued August 22, 2016, provides more flexibility and additional requirements in structuring management contracts. Previously, Rev. Proc. 97-13 provided safe harbors for structuring management contracts to prevent prohibited private business use.
Rev. Proc. 2017-13 issued January 17, 2017, clarifies new rules for management contracts used by tax-exempt bond issuers; these rules modify, amplify and supersede Rev. Proc. 2016-44.
Compensation amount and timing may not be contingent on net profits or loss from the managed property’s operation. A service provider’s repayment of direct expenses won’t be treated as providing a share of net profits or losses. Capitation, periodic fixed and per-unit fee definitions and clarification that fees aren’t considered to be sharing the net profits or bearing a share of the burden of loss are in Rev. Proc 2017-13.
Insufficient cash flows of the managed property leading to compensation deferral won’t be considered contingent on net profit or loss if the following are met:
- The compensation is subject to an annual payment requirement
- There are reasonable consequences for late payments, e.g., fees or interest charges
- The contract requires payment of the deferred compensation within five years of the original due date
The contract term must be limited—including all renewal options—to the lesser of 30 years or 80 percent of the managed property’s weighted, average reasonable expected economic life. Rev. Proc. 2017-13 provides that land will be treated as having an economic life of 30 years, if 25 percent or more of the bond’s net proceeds financed the managed property’s financed land.
Significant control must be exercised on the property’s use. Rev. Proc. 2016-44 introduced several items requiring qualified users to approve rates to exercise control. Rev. Proc. 2017-13 states the rate approval requirement will be satisfied if any of these are met:
- An approval of a reasonable, general description of the rate-setting method
- A requirement that the service provider charge rates are reasonable and customary as specifically determined
- Negotiation with an independent third party
Rev. Proc. 2017-13 applies to any management contract entered into on or after January 17, 2017. An issuer may apply these rules to any management contract entered into before January 17, 2017.
Contact your BKD advisor if you have questions.