IRS Issues New Safe Harbor for Management Contracts

September 8, 2016

On August 22, 2016, the Internal Revenue Service (“IRS”) issued Rev. Proc. 2016-44 which provides new safe harbor conditions under which management contracts with private entities, entered into or materially modified after August 22, 2016[1], do not result in impermissible private business use of tax-exempt bond financed property. The new safe harbor is of interest to any issuer of tax exempt bonds, such as governmental entities and 501(c)(3) organizations (collectively “qualified users,[2]), service providers[3] to any such issuer and lenders and other parties involved in tax exempt public financing transactions. The new safe harbor takes a “more flexible and less formulaic approach” than the prior safe harbors established in Rev. Proc. 97-13, Rev. Proc. 2001-39 and Notice 2014-67.

One of the most notable changes under the new Rev. Proc. 2016-44 safe harbor is that the allowable term of a management contract is significantly expanded from a term of as short as one, three, or five years under the prior safe harbors to a term that can be as long as 30 years. Another important change under the new safe harbor is that management contracts are specifically permitted to include compensation in the form of reimbursement of expenses[4].

In order to satisfy the new safe harbor, a management contract must meet each of the following characteristics:

  1. Compensation must be reasonable for the services rendered;
  2. Service provider must not be compensated based on a share of net profits from the managed property (i.e., no part of the compensation takes into account, or is contingent upon (a) the managed property’s net profits, or (b) both the managed property’s revenues and expenses);
  3. The service provider must not bear the burden of any share of net losses from the managed property (i.e., the service provider’s compensation and obligation to pay expenses do not take into account (a) the managed property’s net losses, or (b) both the managed property’s revenue and expenses);
  4. The term of the contract must be no longer than the lesser of (a) 30 years, or (b) 80 percent of the weighted average reasonably expected economic life of the managed property (a material modification to the contract will result in a retesting of the term);
  5. The qualified user must maintain a significant degree of control over the use of the managed property. For example, the management contract should specifically provide that the qualified user must, at a minimum, approve the annual budget, capital expenditures and any disposition of the managed property by the service provider, the rate charged for use of the managed property, and the general nature and type of use of the managed property;
  6. The qualified user must bear the risk of loss for damage or destruction of the managed property (third party insurance does not cause a failure of this requirement);
  7. The service provider must agree that it is not entitled to and will not take any tax position that is inconsistent with being a service provider to the qualified user with respect to the managed property (i.e., no depreciation, amortization, investment tax credit, or rent deduction); and
  8. The service provider must not be in a role or relationship with the qualified user that substantially limits the qualified user’s ability to exercise its rights under the management agreement. There will not be a prohibited relationship if: (a) 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; (b) the governing body of the qualified user does not include the service provider’s CEO or chairperson of the service provider’s governing body (or equivalent positions); and (c) the CEO of the service provider is not the CEO of the qualified user or any of the qualified user’s related parties.

Dykema should be consulted to assist in drafting or reviewing any such contracts in order to insure that the contracts meet the applicable safe harbors and do not result in impermissible private business use. Please contact Matt Shell (248-203-0848 or, Gina Torielli (734-214-7630 or, Kathrin Kudner (734-214-7697 or, or your Dykema relationship attorney if you have any questions.

[1] Rev. Proc. 2016-44 supersedes Rev. Procs. 97-13 and 2001-39 and section 3.02 of Notice 2014-67 for contracts entered into or materially modified after August 22, 2016. Rev. Proc. 2016-44 applies to any management agreement entered into after August 22, 2016 and may be applied to any management agreement entered into before that date. An issuer may continue to apply the safe harbors of Rev. Prov. 97-13 as modified by Rev. Proc. 2001-39 and amplified by Notice 2014-67, to a management contract that is entered into before August 18, 2017 and that is not materially modified or extended on or after August 18, 2017 (other than pursuant to a renewal option). For contracts entered into or materially modified between August 22, 2016 and August 18, 2017, either Notice 2014-67 or Rev. Proc. 97-13 safe harbors may be relied upon.

[2] A “qualified user” is any governmental person or 501(c)(3) organization the activities of which do not constitute an unrelated trade or business with respect to its activities in relation to the tax exempt bond financed project. Examples include hospitals and universities.

[3] A “service provider” is any person other than a qualified user who provides services to, or for the benefit of, a qualified user. Examples include IT providers, hospital based physicians and janitorial services.

[4] Reimbursements of actual and direct expenses paid by the service provider to unrelated parties are disregarded as compensation for purposes of the new safe harbor.

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