The Issue Spot: Qualified Management Contracts
Public Finance in Focus
Qualified Management Contracts Governmental issuers and section 501(c)(3) borrowers often outsource the management of bond-financed facilities to for-profit companies to enhance efficiency, mitigate risk, and, in certain cases, increase revenue. If not properly structured, a third-party management contract can result in private business use that could jeopardize the tax-exempt status of the bonds. The IRS has periodically set forth safe harbors regarding what constitutes a “qualified management contract” that will not create private business use. While the rules for compliance are complicated and filled with nuance, a summary of the salient provisions of the IRS’s most recent guidance regarding qualified management contracts – Revenue Procedure 2017- 13 – is set forth below. Management Contract Defined A “management contract” is a management, service, or incentive payment contract between a qualified user (i.e., the governmental entity or, in the case of “qualified 501(c)(3) bonds,” a section 501(c)(3) borrower) and a service provider under which the service provider provides services for a managed property after its placed in service date. A governmental entity must treat any entity that is not a governmental entity, including a section 501(c)(3) entity, as a service provider. In the case of qualified 501(c)(3) bonds, a section 501(c)(3) borrower must treat any entity other than a governmental entity or another 501(c)(3) entity that is acting in furtherance of its exempt purposes as a service provider. Limits on the Term Length Prior IRS guidance included various term limits for management contracts depending upon the applicable compensatory arrangement. Rev. Proc. 2017-13 simplifies these rules by providing just one rule – the term of the management contract, including all renewal options, must not be greater than the lesser of 30 years or 80% of the weighted average reasonably expected economic life of the managed property. A “renewal option” is a provision under which either party has a legally enforceable right to renew the management contract. Thus, a provision under a management contract that is automatically renewed absent cancellation by either party is not a renewal option, even if it is expected to be renewed.
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