Just a few short months after essentially re-writing the rules on management contracts for bond-financed property, the IRS is at it again. On January 17th the IRS gave advance notice of the publication of Revenue Procedure 2017-13. While Rev. Proc. 2017-13 won’t officially be published until February 6th, the IRS has made a copy of the new guidance available immediately for review.
The new guidance generally does not alter the “principles-based approach” that was announced by the IRS in Rev. Proc. 2016-44, focusing on the following factors: (1) issuer control over projects, (2) issuer bearing of risk of loss, (3) the economic lives of managed projects, and (4) consistency of tax positions taken by the service provider.
Rather, the IRS is publishing Rev. Proc. 2017-13 to address questions regarding permissible compensation arrangements that have been raised by the tax-exempt bond community in the wake of the new guidance, as well as make other changes that are beyond the scope of this blog post.
Rev. Proc. 2016-44 was notable for abandoning much of the details on compensation seen in the prior IRS guidance. In prior guidance found originally in Rev. Proc. 97-13, the IRS set forth detailed rules on the particular types of compensation that could be offered, such as “capitation fees”, “periodic fixed fees”, and “per-unit fees”. Several safe harbors were offered, with different mixes of compensation permitted and with varying terms. If a management contract met the requirements of a particular safe harbor, it would give the issuer and its counsel assurance that the contract did not result in private business use.
Rev. Proc. 2016-44 did away with these safe harbors and deleted references to the particular types of compensation offered in such contracts that qualified. In their place, the IRS offered a simple statement that compensation could not be based on a share of net profits, adding that “compensation will not be treated as providing a share of net profits if no element of the compensation takes into account, or is contingent upon, either the managed property’s net profits or both the managed property’s revenues and expenses for any fiscal period. For this purpose, the elements of the compensation are the eligibility for, the amount of, and the timing of the payment of the compensation.”
In response to concerns regarding the lack of guidance on particular types of compensation offered in a management contract, the IRS is resurrecting the concepts of “capitation fees”, “periodic fixed fees”, and “per-unit fees,” with essentially no changes to the definitions of these terms, to make clear that a contract that contains one or more of these types of fees will not run afoul of the prohibition on compensation based on a share of net profits. The IRS is not, however, resurrecting the rigid safe harbors that it did away with in Rev. Proc. 2016-44; contracts are free to have any mix of compensation based on these specified fees as the parties determine.
The IRS also addressed concerns regarding the circumstances in which the timing of payment of compensation would be considered by the IRS to be contingent upon net profits or net losses. Specifically, the IRS considered a situation in which the payment of compensation had been deferred due to insufficient cash flow – under what circumstances would such a deferral suggest that the timing of payment was contingent upon net profits or net losses?
The IRS addressed this problem by creating a safe harbor: so long as the contract required that compensation be paid at least annually, with reasonable consequences for late payment (e.g., reasonable interest charges or late fees), and any deferred compensation required to be paid within five years from the original due date, the deferral would not result in a finding that the compensation was contingent upon new profits or net losses.
Rev. Proc. 2017-13 will apply to any management contract entered into after January 17, 2017, unless an election is made by the issuer to apply the old rules (but only for contracts entered into before August 18, 2017). Issuers are encouraged to consult with counsel on other ramifications of Rev. Proc. 2017-13 before entering into any management contract to which its rules may apply.