Corporate, Securities & Tax

On August 22, 2016 the IRS released a new revenue procedure, Rev. Proc. 2016-44. It provides revised safe harbors under which a management contract does not result in private business use of projects financed with tax-exempt bonds.

Rev. Proc. 2016-44 eliminates the former limits on fixed and variable compensation parameters in management contracts, including examination of termination provisions. Although Rev. Proc. 2016-44 contains some favorable revisions to the previous safe harbor guidance under Rev. Proc. 97-13, Rev. Proc. 2001-39, and Notice 2014-67, including flexibility and incentives in compensation arrangements and longer contract terms, there remains prohibitions and the addition of constraints.

Rev. Proc. 2016-44 provides that if a management contract meets all six of the applicable conditions listed below, or is an eligible expense reimbursement arrangement (compensation consists of reimbursement of actual and direct expenses paid by the service provider to unrelated parties and reasonable related administrative overhead expenses of the service provider), the management contract does not result in private business use.

1. General Financial Requirements
   In general payments to the service provider must be reasonable compensation for services rendered. The contract cannot provide for any share of net profits from the operation of the managed property. However, incentive compensation will not be treated as providing a share of net profits as long as certain criteria are met. Additionally, the contract must not impose the burden of bearing any share of net losses from the operation of the managed property by the service provider.

2. Term of Contract
   The term of the contract, including all renewal options, cannot exceed the lesser of 30 years or 80% of the weighted average reasonably expected economic life of the managed property.

3. Qualified User Control of Managed Property
   The qualified user (a governmental person or 501(c)(3), depending on the issuance and project) must have a significant degree of control over the managed property. Such control can be demonstrated by control over the managed property with respect to approval of an annual budget, capital expenditures, each disposition of property that is part of the managed property, use rates, and the general nature and type of use (the types of services provided).

4. Risk of Loss to Qualified User
   The qualified user must bear the risk of loss upon damage or destruction of the managed property. The qualified user may insure against risk of loss and may impose a penalty upon the service provider for failure to operate the managed property pursuant to the terms of the contract.

5. No Inconsistent Tax Position
   The contract must provide that the service provider agrees that it will not and is not entitled to take any tax position inconsistent with being a service provider (e.g. taking any depreciation or amortization, or deduction for any payment as rent for the managed property).

6. Relationship - Limiting Exercise of Rights
   Similar to Rev. Proc. 97-13, the service provider cannot have any role or relationship with the qualified user that would limit the qualified user’s ability to exercise its rights under the contract. The safe harbor for this provision can be met if the service provider (e.g. employees or directors) has no more than 20% of the voting power of the qualified user’s governing body, the governing body of the qualified user does not include the service provider’s CEO or its chairperson. In addition, the CEO of the service provider cannot be the CEO of the qualified user or any of its related entities.

The revised safe harbors are effective for any management contract that is entered into on or after August 22, 2016, and an issuer may opt to apply the new safe harbor to any management contract entered into earlier. Additionally, an issuer may apply the prior safe harbors to a management contract that is entered into prior to August 18, 2017, that is not materially modified on or after August 18, 2017, except with respect to certain renewal options.

Although the liberalization in Rev. Proc. 2016-44 provides a significant improvement, we will continue to monitor various aspects and interpretations.

This alert was written by Harold Altscher and Luisella P. McBride, lawyers in the Public Finance practice group at Miles & Stockbridge in the firm’s Baltimore, Maryland office.

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