In a recent revenue procedure (Rev. Proc. 2016-44), the Internal Revenue Service (IRS) revised and expanded significantly the safe harbor applicable to the “management contract” provisions of Section 141 of the Internal Revenue Code. Management contracts can create prohibited “private use” of property financed by tax-exempt bonds. Previously, management contracts were tested under the safe harbor provisions of Rev. Proc. 97-13 (as modified by Rev. Proc. 2001-39 and amplified by Notice 2014-67), which required management contracts to meet certain requirements with respect to the term of the agreement and the type of compensation paid to the service provider. Rev. Proc. 2016-44 takes a much more flexible and less formulaic approach toward the terms of management contracts and should generally give “qualified users” (issuers of tax-exempt bonds, or conduit borrowers with respect to qualified 501(c)(3) bonds) greater ability to enter into management contracts that provide for the payment of variable compensation to the service provider. Rev. Proc. 2016-44 provides that a management contract will not result in private business use if:
- It meets certain general financial requirements (i.e., the payments to the service provider represent reasonable compensation for services rendered and the service provider is not provided with a share of net profits from the operation of the managed property);
- The contract does not impose upon the service provider the burden of bearing any share of the net losses from the operation of the managed property;
- The term of the contract, including all renewal options, does not exceed the lesser of 30 years or 80% of the weighted average reasonably expected economic life of the managed property;
- The qualified user exercises a significant degree of control over the use of the managed property;
- The qualified user bears the risk of loss upon damage or destruction of the managed property;
- The service provider agrees not to take any tax position that is inconsistent with being a service provider to the qualified user with respect to the managed property; 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.
The IRS stated in Rev. Proc. 2016-44 that the new safe harbor provisions are intended to apply a more principles-based approach to the management contract rules, and this certainly seems to be the case given the much-increased flexibility to pay variable (rather than fixed) compensation to the service provider over a longer period of time than originally permitted under prior IRS guidance. As noted above, however, the service provider must “agree” (presumably in the management contract itself) not to take any tax position that is inconsistent with being a service provider to the qualified user with respect to the managed property; this is an additional provision that was not required by previous IRS guidance and cannot be overlooked by the drafters of such contracts going forward. The safe harbor set forth in Rev. Proc. 2016-44 applies to any management contract entered into (or materially modified) on or after August 22, 2016, but issuers may elect to apply Rev. Proc. 2016-44 to any management contract entered into before August 22, 2016. Also, until February 18, 2017, an issuer may elect to apply the original management contract safe harbor provisions of Rev. Proc. 97-13 (as modified by Rev. Proc. 2001-39 and amplified by Notice 2014-67) to a new management contract that is not materially modified or extended on or after February 18, 2017. Calfee lawyers regularly counsel bond issuers, developers and managers on the management contract rules and can assist in crafting management contracts that comply with the more flexible and favorable IRS guidance that is now available.
For additional information and discussion on this topic, please get in touch with your regular Calfee contact or one of the attorneys listed below: Michael K. Gall 216.622.8460 firstname.lastname@example.org Teresa Metcalf Beasley 216.622.8584 email@example.com Salvatore J. Totino 216.622.8331 firstname.lastname@example.org
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