IRS Issues New Management Contract Safe Harbors

On Monday, August 22, the Internal Revenue Service (“IRS”) issued Revenue Procedure 16-44 (“Rev. Proc. 16-44”), which revises and expands the safe harbor provisions for long-term management contracts relating to property financed with tax-exempt bonds. Under the new procedures, permissible maximum terms of qualified management contracts are extended from 15 years to 30 years, and certain compensation criteria are revised. The new safe harbor provisions, as contrasted with the existing Revenue Procedure 97-13, apply more principles-based tests rather than the current mechanical tests.

General Background

Section 141(b)(1) of the Internal Revenue Code of 1986, as amended, (the “Code”) generally provides that an issue meets the private business use test if more than 10 percent of the proceeds of the issue are to be used for any private business use. The Code defines private business use as use (either directly or indirectly) in a trade or business carried on by any person other than a governmental unit. Nearly 20 years ago, the IRS released Revenue Procedure 97-13, which set safe harbor provisions under which a management contract would not result in private business use. While helpful, the Revenue Procedure 97-13 safe harbors were overly mechanical and rigid. With Notice 2014-67, the IRS provided issuers with somewhat more flexibility in entering into such contracts.

Revenue Procedure 97-13, as amplified by Notice 2014-16, required an evaluation of the maximum term of the contract and the compensation formula for the managing entity. Long term management contracts could not exceed a fifteen year maximum term. Compensation under long-term contracts was restricted to a 80% or 95% fixed fee depending on the maximum term of the contract. These safe harbor provisions had long been criticized as overly restrictive, particularly as an increasing number of governmental entities have turned to public-private partnerships involving complex long-term management contracts as preferred methods of financing improvements.

As noted, the new Rev. Proc. 16-44 would extend the maximum term of a qualified management contract from 15 to 30 years (or a lesser term based on 80% of the weighted average reasonably expected economic life of the managed property). It also removes the rigid compensation criteria and, alternatively, generally permits “any type of fixed or variable compensation that is reasonable compensation for services rendered under a contract,” although it should be noted that the new rules still impose restrictions on net profit arrangements. The Procedure adds several additional practical requirements for qualified management contracts, including that the state or local government exercises “a significant degree of control or use of the managed property” and bear “the risk of loss upon damage or destruction to the managed property”; and that the private party must agree not to take any tax position inconsistent with its status as a service provider, including that it may not take tax benefits for depreciation or investment tax credit.

Specific Provision of New Rules

Specifically, the safe harbor provided by Rev. Proc. 2016-44 is generally available to management contracts that satisfy the following six requirements:

  1. A contract (i) must provide only for “reasonable compensation,” (ii) must not give the service provider “a share of net profits,” and (iii) must not impose the burden of sharing any of the net losses on the service provider.
  2. The contract term, including renewal options, must not be longer than the lesser of 30 years or 80% of the weighted average reasonably expected economic life of the “managed property.” If contract terms relevant to the safe harbor analysis are “materially modified,” the contract must be retested as a new contract.
  3. The “qualified user” (depending on the project, this is either a governmental person or a 501(c)(3) organization) must exercise a “significant degree of control” over the managed property.
  4. The qualified user must bear the risk of loss upon damage or destruction of the managed property.
  5. The service provider must agree” not to take any tax position that is inconsistent with being a service provider,” e.g., by claiming depreciation with respect to (and presumably, ownership of) the managed property, or by claiming a deduction for a payment as rent (and presumably classifying itself as a lessee of some or all of the managed property).
  6. The service provider must not have any role or relationship with the qualified user that acts to substantially limit the qualified user’s ability to exercise its rights under the contract. This requirement is deemed to be satisfied upon a showing that: (i) certain individuals affiliated with the service provide (e.g., directors and officer) do not control 20% or more of the vote of the qualified user’s governing body, (ii) the qualified user’s governing body does not include the service provider’s chief executive officer or its chairperson (or the equivalents), and (iii) the CEO of the service provider is not the CEO of the qualified user (or CEO of any entity related to the qualified user).

Effective Date

Rev. Proc. 2016-44 applies to any management contract entered into on or after August 22, 2016, and may be applied to contracts entered into before that date. Additionally, during an initial transition period through February 18, 2017, issuers and borrowers can apply either the prior safe harbor provisions or the new safe harbors set forth in Rev. Proc. 16-144. The new provisions have been received favorably by bond industry professionals for providing a clearer and more flexible approach to structuring tax-exempt financings with private management components. For more information regarding Rev. Proc. 16-44 and its impacts, please contact any member of our Public Finance department.

If you have any questions, please contact any member of our Public Finance Group.


Sherman & Howard L.L.C. has prepared this advisory to provide general information on recent legal developments that may be of interest. This advisory does not provide legal advice for any specific situation and does not create an attorney-client relationship between any reader and the Firm.

©2016 Sherman & Howard L.L.C.                                           August 30, 2016