Who actually controls a joint venture between a not-for-profit hospital system and a for-profit partner may become the deciding factor in determining whether such partnerships are tax-exempt or subject to tax under a recent appeals court ruling.
In a 20-page decision released Nov. 7 and first reported by Modern Healthcare (Nov. 10, p. 4), a three-judge panel from the 5th U.S. Circuit Court of Appeals in New Orleans overruled an Austin, Texas, federal judge who last year ruled in summary judgment that St. David's HealthCare System, Austin, was tax-exempt. In sending the case back to district court for trial and giving the Internal Revenue Service another shot at collecting taxes from St. David's, the appellate court decision could lead hospitals around the country to reassess their joint venture relationships with for-profit partners, tax lawyers said.
"This is a very strong shot against whole-hospital joint ventures and also raises the issue of whether the far more common ancillary joint ventures will have to pay unrelated business income tax," said Gerald Griffith, a healthcare tax lawyer with the Detroit office of Honigman Miller Schwartz and Cohn. "This opinion is day-and-night different from the district court judgment."
The panel remanded the case back to U.S. District Judge James Nowlin in Austin for trial and vacated Nowlin's order compelling the IRS to return about $1.2 million in tax payments and nearly $1 million in legal fees to St. David's. The six-hospital system is a whole-hospital joint venture between investor-owned HCA, Nashville, and not-for-profit St. David's. In 1996, each partner contributed three hospitals to form St. David's HealthCare Partnership and signed a 54-year partnership agreement. After a 1998 audit, the IRS ruled that because the St. David's system entered a partnership with a for-profit entity, it no longer operated exclusively for charitable purposes and revoked its tax-exempt status in 2000.
The IRS ordered St. David's to pay 1996 taxes for its share of the partnership profits, which it did under protest. The system challenged the IRS ruling in 2001 and last year won at the trial level. Nowlin ordered the IRS to restore St. David's tax exemption, saying it has operated as a charitable organization since its founding in 1925 and has enjoyed tax-exempt status since 1938. Nowlin said while St. David's shares an equal number of partnership board members with HCA, its partnership agreement protects the system's charitable mission. That agreement requires the hospitals to comply with community benefit standards, gives St. David's the right to fire the chief executive officer, name the board chairman, dissolve the partnership and end the management services contract with HCA subsidiary Galen Health Care.
But the appellate judges were not persuaded.
"If more than an insubstantial amount of the partnership's activities further noncharitable interests, then St. David's can no longer be deemed to operate exclusively for charitable purposes," the judges wrote. "Therefore, even if St. David's performs important charitable functions, St. David's cannot qualify for tax-exempt status ... if its activities substantially further the private, profit-seeking interests of HCA."
The appellate judges ruled that if the not-for-profit group cedes control to the for-profit, that action substantially benefits the for-profit partner. "The present case illustrates why, when a nonprofit organization forms a partnership with a for-profit entity, courts should be concerned about the relinquishment of control," the opinion said.
While the judges conceded that St. David's did manage to secure some protections for its charitable mission in the partnership agreement, they argued that those might not be enough. "The partnership documents in this case ... leave us uncertain as to whether St. David's has ceded too much control to HCA."
Griffith said with its ruling the appeals court is establishing a means of determining how much control a not-for-profit must have over a joint venture with a for-profit partner to retain its tax-exempt status.
Neal Kocurek, president and CEO of St. David's HeathCare System, said the ruling was disappointing. "But the judges did narrow the case a lot and we feel very comfortable going to court on the issues they set out there," he said.
HCA spokesman Ed Fishbough said the company believes the decision is an issue between its not-for-profit partner and the IRS. "It doesn't involve HCA," he said.