Private Letter Ruling 201641002: Physicians service agreements entered in connection with staffing medical facility owned by exempt organization that is funded with state bond proceeds do not result in private business use of bond proceeds under §145(a)(2)(B).
Issuer is an instrumentality of State and issues State bonds, the proceeds of which are used to make loans to health and educational institutions located in State. Issuer made loans to Medical Center, an exempt entity, that provides physician services at healthcare facilities owned by Medical Center. Group is the sole member of Medical Group and appoints the directors of Medical Group. Group, through an intermediary taxable subsidiary, acquired all the outstanding stock of Clinic. Clinic is a taxable wholly owned physician practice group.
Pursuant to the Clinic Physicians Service Agreement (CPSA), Clinic physicians provide medical services at the facilities of Group, and in turn Group provides space, equipment and supplies necessary for the physicians to serve patients. The stated term of the CPSA is three years, subject to one-year automatic renewals absent cancelation; either party may terminate the CPSA by giving 30 days written notice. During the three-year term of the CPSA, Group may not amend or terminate the compensation arrangement with Clinic physicians without approval by a majority of the Clinic Board of Directors. Group also compensates Clinic for salaries other than physicians. Physician compensation is an aggregated of fixed fees. The CPSA imposes two reasonability tests on physician compensation to ensure that it is at fair market value. Issuer represents that physician compensation is reasonable. Physicians may also qualify for an annual bonus if certain quality benchmarks are met.
Issuer’s requested for a ruling that the CPSA described below does not result in private business use of the bond proceeds under §145(a)(2)(B). The IRS ruled that the CPSA meets the requirements of §5.04 of Rev. Proc. 97-13, 1997-1 C.B. 632, and will not result in private business use of the bond proceeds under §145(a)(2)(B). The three-year term with automatic renewals absent a cancelation, is within §5.03(7) of Rev. Proc. 97-13, the IRS stated. Other than physician bonuses, physicians are compensated based on either a per-unit or a capitation basis both of which Rev. Proc. 97-13 permits, the IRS added. The IRS also stated that physician bonuses, triggered by factors other than net profits and based on a share of gross revenues from physician billings, are also permitted under Rev. Proc. 97-13.
However, the IRS noted, the CPSA does not meet the requirements of §5.04(2) of Rev. Proc. 97-13, because Group and Clinic are related parties. Therefore, the IRS explained, whether the CPSA causes private business use of the facilities financed with the bonds depends on the facts and circumstances. Because the other elements of Rev. Proc. 97-13 are satisfied, the only question is whether the parties’ relationship will substantially limit the Group’s ability to exercise its rights under the CPSA, the IRS noted. Although Group and Clinic are related parties under Reg. §1.150-1(b), Group is effectively the sole shareholder of Clinic, giving Group ultimate control in the relationship between these two parties, the IRS noted. Further, only up to 20% of the Clinic physicians may be members of the Group’s board, the IRS found. The IRS also noted that the designee of the CEO who serves on Clinic’s board has no special status or special powers and represents less than 10% of the Clinic board. Therefore, the IRS concluded that Clinic cannot control Group and cannot prevent Group from terminating the CPSA.