PUBLIC FINANCE IN FOCUS

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 taxexempt 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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