Monday, November 26, 2012
According to this story from Lancaster Online, last May the IRS denied tax-exempt status to two joint ventures run by Lancaster General Hospital in Lancaster, PA. One of the joint ventures was a 50-50 deal with a for-profit company to run a rehabilitation center; the other was a 50-50 deal with doctors to run an ambulatory surgery center. According to the story, the IRS denied exemption because the 50-50 arrangement did not give Lancaster General (a tax-exempt 501(c)(3) charity) sufficient control over the joint ventures to assure they were run in a charitable manner.
This result indicates that the IRS's "control" test for determining charitable status of joint venture operations between a charity and a for-profit enterprise is still alive and well. The control test first surfaced in the "whole hospital joint venture" ruling, Rev. Rul. 98-15, and then was relaxed somewhat in the "ancillary" joint venture ruling, Rev. Rul. 2004-51. In that latter ruling, which would seem to govern the kinds of transactions involving Lancaster General, the IRS approved a 50-50 ownership arrangement, where the charity (a university in this case) had absolute control over the way in which the substantive services (educational distance learning) were delivered - (e.g., approval of the curriculum, training materials and instructors). After Rev. Rul. 2004-51, the control test sort of disappeared from view as practitioners learned to draft deals around the requirements. But the Lancaster General story indicates that it is still very much alive and enforced by the IRS.
I've frankly never understood why the IRS presses a "control" requirement in the context of ancillary joint ventures. "Ancillary" joint ventures by their nature are simply business deals done by a charity. The question involved in these cases should ONLY be whether the deal is a fair one to the charity (to avoid issues of private inurement and private benefit); if so, then the joint venture interest should be treated like any other commercial activity: that is, subject to the unrelated business income tax if indeed the venture's business is "unrelated" (in many cases, I would suggest that joint ventures entered into by hospitals to expand health services in fact are "related," but that's another story). It is very odd to me that an exempt hospital or exempt university could open a BMW dealership with no ill effects on exemption other than having to pay the UBIT. And a direct investment in a business corporation via stock doesn't create any exemption issues at all, not even UBIT issues. But a business investment done as a joint venture suddenly causes us to break out in hives . . . In my opinion, very odd, and not well-justified by any underlying theory applicable to exempt status.