PLR: Management contract will not result in private business use

Management contract not result in private business use

The IRS publicly released a private letter ruling* in which it was concluded that a management contract entered into by an issuer of tax-exempt bonds for the management of a hotel will not result in private business use, notwithstanding that the contract did not qualify for an applicable safe harbor.

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Specifically, the IRS determined that, with the exception of its duration, the contract satisfied the requirements of the safe harbor and, therefore, was reasonable based on all of the facts and circumstances. PLR 201622003 (release date May 27, 2016, and dated March 1, 2016). Read PLR 201622003 [PDF 62 MB] 

 

*Private letter rulings are taxpayer-specific rulings furnished by the IRS National Office in response to requests made by taxpayers and can only be relied upon by the taxpayer to whom issued. It is important to note that, pursuant to section 6110(k)(3), such items cannot be used or cited as precedent. Nonetheless, such rulings can provide useful information about how the IRS may view certain issues. 

Background

Tax-exempt status generally is denied for “private activity” bonds. A private activity bond is part of any bond issue that meets the private business use test and the private security or payment test. A bond falls afoul of the private business use test if more than 10% of the issue's proceeds are to be used for any private business use. Private business use is defined as direct or indirect use in a trade or business carried on by any person other than a governmental unit. 

The provision of services under a management contract does not itself result in private business use if requirements as to compensation arrangements and other matters are satisfied. Rev. Proc. 97-13, 1997-1 C.B. 632, as amended by Notice 2014-67, 2014-46 I.R.B. 822, sets forth conditions under which a management contract will not result in private business use. It allows for certain contracts in which all of the compensation for services is based on a (1) stated amount, (2) periodic fixed fee, (3) capitation fee, (4) per-unit fee, or (5) a combination of such fees. Compensation cannot be based on a share of net profits, but can be based on a percentage of gross revenues or expenses (but not both). The term of the contract, including all renewal options, must not exceed five years. In addition, a manager must not have any relationship with a bond issuer that substantially limits the issuer's ability to exercise its rights, including cancellation rights. 

Even if a management contract does not meet the safe harbor, the IRS considers the factors provided by Rev. Proc. 97-13 to be useful reference points for determining whether the facts and circumstances indicate private business use.

PLR 201622003

In PLR 201622003, the management fee consisted of: (1) a base fee equal to a percentage of the gross revenue of the hotel; and (2) an incentive fee that, while based on gross revenue, was contingent upon a variant of net profits (i.e., a margin test). Further, the management contract exceeded five years. 

The IRS ruled that despite being partly triggered by a derivative of net profits, the amount of the incentive fee was not actually based on net profits and therefore was not to be treated as a share of gross revenue. Further, the manager had no role or relationship with the issuer that would substantially limit the issuer's ability to exercise its rights under the management contract. The only feature of the management contract that didn’t satisfy the safe harbor was the term, which exceeded five years. The IRS nevertheless concluded that the term was reasonable and that the management contract would not result in private business use. 

 

For more information, contact the Managing Director-in-Charge of KPMG's Washington National Tax Exempt Organizations Tax group

D. Greg Goller | +1 (703) 286-8391 | greggoller@kpmg.com

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