Not-for-profit hospitals must have majority control over their joint ventures with for-profit hospitals if they want to keep their tax-exempt status, the Internal Revenue Service said last week.
A new IRS ruling states that control of charitable assets must reside with the not-for-profit partner, which can achieve that aim by holding a majority of seats on the joint venture's board of directors.
The revenue ruling carries the legal weight of a federal regulation, and when it's published March 23 in the Internal Revenue Bulletin, it will take effect immediately and retroactively to all previous joint ventures. There is no public comment period.
The ruling outlines two joint venture scenarios, one that preserves the tax-exempt status of the not-for-profit and one that doesn't. The 19-page ruling lays out the criteria that weigh for and against a joint venture's passing muster with the IRS.
In addition to requiring that the not-for-profit control a majority of the board seats of the joint venture, the ruling outlines the key functions the joint venture board must control (See chart). That board also can't be a shell company with no real power.
The hospital joint venture model, made popular by Columbia/HCA Healthcare Corp. and refined by other hospital chains, allows not-for-profit corporations to sell their hospitals to a joint venture company formed with a for-profit company. The not-for-profit generally receives 50% of the hospital's value and some seats on the joint company's board.
"Globally, this tells us that a charitable organization that wants to contribute to a joint venture and retain its exempt status puts itself at risk," said T.J. Sullivan, a tax attorney with Gardner Carton & Douglas in Washington and a former IRS attorney who oversaw the agency's policies on tax-exempt organizations. "It has to maintain meaningful control over how its assets are used to ensure charitable benefits."
The ruling insists that the joint company's governing board has to put "charitable purposes" above "the financial benefit of (the company's) owners." The way to ensure that is to give control to the not-for-profit.
"There are criteria identified in the favorable scenario that would require a higher duty, the imposition of a higher standard to the members to run the business for a charitable purpose," said Michael Peregrine, a tax attorney with Gardner Carton & Douglas in Chicago.
The anxiously awaited ruling could spell a slowdown in joint ventures between not-for-profits and for-profits.
"That favorable situation may not exist in the real world," said Phil Royalty, a tax partner at Ernst & Young in Washington. "Joint ventures are still possible to do...but I'm not sure how the for-profits will react to having less than 50% control."
"Many of these 50-50 deals don't meet the criteria," said Dan Bourque, a senior vice president at VHA, a national alliance of not-for-profit hospitals. "This sends a very strong signal going forward that would dampen the desire for 50-50 deals."
Marcus Owens, director of the IRS' exempt organizations division, said the ruling follows the criteria the IRS already has been using when evaluating joint ventures.
Since 1992 the IRS has issued at least four favorable rulings on such joint ventures, but those rulings applied only to specific transactions. About 29 cases are pending, Owens said.
"These financial arrangements are complex," Owens said. "They vary in as many ways as the stars in the sky. There will be an array of facts in each case that will need to be analyzed. People need to review their situations."
The ruling could affect hundreds of transactions, Owens said.
Not-for-profit hospitals that aren't involved in such joint ventures are claiming victory, saying the ruling gives greater protection to charitable assets and community-based healthcare.
"We're delighted with the ruling," Bourque said. "What we laid out (in our December 1996 letter to the IRS) is nearly identical to what came out in this ruling. That's a victory for the protection of charitable assets in communities. We will continue to be vigilant on this because investor-owned hospitals can be very creative."
Meanwhile, those involved in such deals bemoan the retroactive ruling, which potentially could place every joint venture between the two ownership camps under scrutiny.
"One of the key points we made in our statement (to the IRS) is that this ruling not be retroactive," said Royalty, who represented a coalition of for-profits and not-for-profits that weighed in on the ruling in December 1996. "That means everyone who's done a deal is at risk. The IRS could revoke your tax-exempt status. They've said they're going to play hardball."
The ruling might force more outright sales of not-for-profits to for-profits, some observers said.
But one of the biggest fans of joint ventures, Santa Barbara, Calif.-based Tenet Healthcare Corp., remains undaunted by the ruling.
Tenet, in fact, believes the ruling might propel joint ventures "because now we know how to structure them," spokesman Lance Ignon said.
Tenet has at least 25 joint ventures, two of which could be subject to this ruling because they involve the pooling of assets.
The ruling does leave some gray areas, said Elizabeth Mills, a tax attorney at McDermott Will & Emery in Chicago. "They talk about two polar opposites, a good example and a bad example," Mills said. "If you have some bad facts and some good facts, you still don't know where you are."