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Management Contracts and Private Business Use: IRS Releases Favorable Guidance

Coming as welcome news to those involved in the municipal bond market, Internal Revenue Procedure 2016-44 (scheduled to be published on September 6, 2016 and available here) provides helpful guidance for governmental issuers and 501(c)(3) borrowers entering into long-term contracts with private entities for the management and operation of facilities financed with tax-exempt bonds by allowing more flexible arrangements than were previously permitted as safe harbors in Revenue Procedure 97-13.  Recognizing the changing market and emergence of public-private partnerships, Revenue Procedure 2016-44 sets forth safe harbors that take “a more flexible and less formulaic approach” than Revenue Procedure 97-13 in determining whether a management contract gives rise to private business use.

Examples of bond-financed facilities that are often subject to management contracts include parking lots and garages, cafeterias, hotels, convention centers, and health care facilities.

Under Revenue Procedure 2016-44, a management contract generally will not give rise to private business use so long as:

  • The payments to be made to the service provider qualify as “reasonable compensation” and are not based on “net profits” of the managed property;

  • The contract does not, in substance, impose upon the service provider the burden of bearing any share of net losses from the operation of the managed property;

  • The term of the contract (including all renewal options) is no greater than the lesser of 30 years or 80 percent of the weighted average reasonably expected economic life of the managed property;

  • The governmental issuer or 501(c)(3) borrower exercises a significant degree of control over the use of the managed property and bears the risk of loss upon damage or destruction of the managed property;

  • The service provider agrees not to take an inconsistent tax position (e.g., claiming depreciation or amortization) with respect to the managed property; and

  • The service provider does not have any role or relationship with the governmental issuer or 501(c)(3) borrower that, in effect, substantially limits the issuer’s or borrower’s ability to exercise its rights under the management contract.

Revenue Procedure 2016-44 replaces the more rigid requirements of Revenue Procedure 97-13, which required the parties to adhere to certain restrictive types of compensatory arrangements depending upon the length of the contract term, often resulting in unnecessarily complicated agreements that were not economically efficient for either party.

The safe harbors under Rev. Proc. 2016-44 apply to any management contract that is entered into on or after August 22, 2016, but may also be applied by governmental issuers (and presumably 501(c)(3) borrowers, although clarification may be needed) to any management contract that was entered into before August 22, 2016.

© 2020 Bracewell LLP


About this Author

R. Todd Greenwalt, Tax Attorney, Bracewell Law Firm

Todd's practice focuses on governmental entities and tax-exempt organizations, advising clients with regard to tax-exempt financings and other business transactions, and resolving tax-exempt status issues.

His clients include all types of state and local governmental entities, hospitals, other health care organizations, colleges and universities, charter schools, museums, arts organizations, community and economic development organizations, private foundations, advocacy groups, and other charities. Todd serves as bond counsel and advises health...

Victoria N. Ozimek, Bracewell, Tax Credit Obligations Lawyer, bond Issuance Attorney

Victoria Ozimek offers legal advice to clients regarding all aspects of tax advantaged obligations, from vetting the tax issues on proposed financing structures to assisting issuers with post-issuance compliance matters such as remedial actions and private business use analyses. In addition to traditional state and local government financings, Victoria has worked on transactions for the financing of multifamily and single family housing, universities and colleges, charter schools, airports and seaports, and water facilities. She has also acted as special tax counsel to a number of issuers in situations where an issuer's regular counsel may not be in a position to provide the specific tax experience needed. 

In addition to advising clients regarding the structuring of transactions, Victoria has assisted issuers with responding to examinations of obligations by the Internal Revenue Service (IRS) and, if necessary, negotiating with the IRS regarding any identified issues. She has also advised issuers regarding the IRS's Voluntary Closing Agreement Program. When needed, Victoria has worked with clients to secure private letter rulings and other guidance from the IRS regarding the tax effect of a proposed action. 

Victoria consistently seeks to provide issuers with the tools needed to successfully manage the requirements imposed by federal tax law by utilizing tax due diligence process as means to communicate with issuers regarding their compliance obligations and regularly seeking opportunities to educate the financing team regarding recent developments. Victoria is the current chair of the Education and Member Services Committee for the National Association of Bond Lawyers and is a frequent speaker on tax matters with respect to tax-advantaged debt.     

Brian P. Teaff, Business Transaction Attorney, Bracewell Law Firm

Brian Teaff has a multifaceted tax practice, advising clients in connection with tax-exempt financings and other business transactions in the public finance area, as well as counseling public charities and private foundations on a wide range of tax planning and compliance matters. In addition, Brian advises a variety of types of clients with respect to the "opportunity zone" provisions enacted under the Tax Cuts and Jobs Act of 2017. 

In his public finance practice, Brian serves as tax counsel on governmental and conduit financings where he...