The Internal Revenue Service is offering a safe harbor for businesses using property that has been financed with tax-exempt bonds.
Revenue Procedure 2016-44 provides safe harbor conditions under which a management contract does not result in private business use of property financed with governmental tax-exempt bonds under Section 141(b) of the Tax Code or cause the modified private business use test for property financed with qualified 501(c)(3) bonds under Section 145(a)(2)(B) to be met.
Section 141(b) generally provides that an issue meets the private business use test if more than 10 percent of the proceeds of the issue are to going to any private business use, such as a trade or business carried on by any person other than a governmental unit.
Under the safe harbor, the payments to the service provider under the contract need to be reasonable compensation for the services provided during the term of the contract. Compensation can include payments to reimburse expenses paid by the service provider and administrative overhead. The contract should not provide a share of net profits from operating the managed property to the service provider and it should not impose upon the service provider the burden of bearing any share of net losses from operating the managed property.
The term of the contract, including all the renewal options, should be no more than either 30 years or 80 percent of the weighted average reasonably expected economic life of the managed property. A qualified user needs to exercise a significant degree of control over the use of the managed property, such as approving the annual budget, capital expenditures, each disposition of property, rates charged for use of the property, and the general nature and type of use of the property. The user must also bear the risk of loss upon damage or destruction of the managed property.
The service provider needs to agree it isn’t entitled to any tax position that’s inconsistent with being a service provider to the qualified user of the managed property. For example, the service provider must agree not to take any depreciation or amortization, investment tax credit, or deduction for any payment as rent on the managed property.
The service provider also must not have any role or relationship with the qualified user that, in effect, substantially limits the qualified user’s ability to exercise its rights under the contract, based on all the facts and circumstances.
As a safe harbor, a service provider will not be treated as having a role or relationship if no more than 20 percent of the voting power of the qualified user’s governing body is vested in the directors, officers, shareholders, partners, members, and employees of the service provider. The governing body of the qualified user also should not include the CEO of the service provider or the chairperson (or an equivalent executive) of the service provider’s governing body; and the chief CEO of the service provider should not be the CEO of the qualified user or any of the qualified user’s related parties.
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