On January 17, 2017 the Internal Revenue Service (“IRS”) issued Rev. Proc. 2017-13. Rev. Proc. 2017-13 modifies, amplifies and supersedes the management contract safe harbors outlined in Rev. Proc. 2016-44 to address certain questions concerning types of compensation, the timing of payment of compensation arrangements, the treatment of the economic life of land, and methods of approving rates applicable to management contracts. Rev. Proc. 2017-13’s clarifications and modifications to Rev. Proc. 2016-44 are summarized below.
Replaces Safe Harbors
Rev. Proc. 2016-44 replaced the safe harbors described in Rev. Proc. 97-13 and certain subsequent guidance with a new approach to analyzing private business use arising under management contracts. In particular, Rev. Proc. 2016-44 permitted up to 30-year management contracts and almost any type of compensation as long as the requirements in section 5.02 of the procedure were met. Since the publication of Rev. Proc. 2016-44, many in the bond community had concerns with the application of the provisions in section 5.02. Through the issuance of Rev. Proc. 2017-13, the IRS is addressing some of these concerns. The safe harbors described in Rev. Proc. 2017-13 change the analysis of what used to be required under Rev. Proc. 2016-44 and Rev. Proc. 97-13.
Types of Compensation
Under Rev. Proc. 2016-44, for a management contract to satisfy the safe harbor against private business use, the contract could not provide the service provider a share of the net profits or require the service provider to bear the burden of any net loss from the operation of the managed property. Questions were presented to the IRS concerning types of compensation deemed to not provide a share of net profits in previously applicable revenue procedures, in particular, capitation fees, periodic fixed fees and per-unit fees. Additional questions concerned whether a service provider’s payment of operation expenses of the managed property without reimbursement from the qualified user affects the treatment of these types of compensation. Rev. Proc. 2017-13 clarifies that compensation for capitation fees, periodic fixed fees, per-unit fees and some forms of incentive compensation (all of which had generally been permitted under Rev. Proc. 97-13) will not be treated as providing a share of the net profits or requiring the service provider to bear any net losses.
Timing of Compensation
Rev. Proc. 2016-44 also provided that the timing of compensation cannot be contingent on net profits or net losses arising from the operation of managed property. Questions were presented to the IRS concerning the effects of these restrictions on the timing of payment. Rev. Proc. 2017 13 clarifies that compensation subject to an annual payment requirement and reasonable consequences for late payment (such as reasonable interest or late charges) will not be treated as contingent upon net profits or net losses insofar as the contract includes the requirement that the qualified user will pay the deferred compensation within five years of the original due date of the payment.
Treatment of Land
Rev. Proc. 2016-44 additionally provided that the term of a management contract, including the renewal thereof, cannot be greater than the lesser of 30 years or 80% of the weighted average reasonably expected economic life of the managed property. Pursuant to Rev. Proc. 2016-44, the economic life of property is determined under section 147(b) of the federal tax code, without regard to section 147(b)(3)(B)(ii), which provides that “if 25 percent or more of the net proceeds of any issue is to be used to finance land, such land will be taken into account . . . and shall be treated as having an economic life of 30 years.” Questions were presented to the IRS concerning the exclusion of land when the cost of the land accounts for a significant portion of the managed property. Rev. Proc. 2017-13 clarifies that economic life is determined in the same manner as under section 147(b) as of the beginning of the management contract term. Therefore, land is treated as having an economic life of 30 years if 25% or more of the net proceeds of the issue which finances the managed property is used for the purchase of land.
Methods of Approving Rates
Finally, Rev. Proc. 2016-44 provided that the qualified user must exercise a significant degree of control over the managed property. If the contract provides that the qualified user must approve, among other things, rates charged for the use of the managed property, this requirement is met. Questions were presented to the IRS concerning the requirement to approve rates in circumstances where it may not be feasible to approve every specific rate charged. Rev. Proc. 2017-13 clarifies that a qualified user meets the approval of rates requirement when it approves a reasonable general description of the method used to set the rates or when it requires the service provider to charge rates that are reasonable and customary as specifically determined by, or negotiated with, an independent third party.
Dates of Applicability
Rev. Proc. 2017-13 applies to any management contract entered into on or after January 17, 2017, and an issuer may also apply Rev. Proc. 2017-13 to any management contract entered into before January 17, 2017. Issuers may additionally apply the safe harbors in Rev. Proc. 97-13, as modified by Rev. Proc. 2001-39 and amplified by Notice 2014-67, to a management contract entered into on or before August 18, 2017 which is not thereafter materially modified. This means that after August 18, 2017 all new and materially modified management contracts (including modified management contracts that were originally entered into under prior guidance) will be subject to the Rev. Proc. 2017-13 safe harbor.
While Rev. Proc. 2017-13 is generally viewed as a welcome clarification of the safe harbors introduced by Rev. Proc. 2016-44, several aspects of the new procedure will need to be considered on a case by case basis to determine how best to apply the guidance. The Treasury Department and the Internal Revenue Service may also issue additional guidance in the future to address remaining questions. The Kutak Rock public finance tax department will continue to monitor developments relating to this matter.
Kutak Rock LLP
Rev. Proc. 2017-13 is available online at https://goo.gl/xASjIz
Rev. Proc. 2016-44 is available online at https://goo.gl/f8GO9r
Rev. Proc. 97-13 is available online at https://goo.gl/fDWOB9
Questions, comments or corrections regarding this memorandum may be addressed to its authors.