Permissible Financial Arrangements
Rev . Proc . 2017-13 limits how a service provider is compensated . Unless the only compensation under a management contract consists of reimbursements of actual and direct expenses paid by the service provider to unrelated parties and reasonably related administrative overhead expenses of the service provider , the following requirements generally must be satisfied :
• Reasonable Compensation . Payments to the service provider must be reasonable compensation for the services rendered . For these purposes , payments to reimburse the service provider ’ s actual and direct expenses and related administrative overhead expenses must be included as compensation .
• No Net Profits . The service provider cannot receive a share of net profits from the operation of the managed property . There is no sharing of net profits if no element of the compensation takes into account , or is contingent upon , either the managed property ’ s net profits or both the managed property ’ s revenues and expenses ( other than any reimbursements of direct and actual expenses paid by the service provider to unrelated third parties , not including employees ) for any fiscal period . Incentive compensation will not result in a sharing of net profits if eligibility is determined by the service provider ’ s performance in meeting standards that measure quality of services , performance , or productivity ( i . e ., qualitative incentive compensation for meeting certain performance metrics ).
• No Bearing of Net Losses . The service provider cannot bear any share of net losses from the managed property .
This particular requirement often demands careful analysis by a tax attorney experienced with the management contract rules to ensure that the amount and timing of compensation and unreimbursed expenses are permissible under Rev . Proc . 2017-13 .
• Permissible Arrangements . Certain types of compensation will not be treated as providing a share of net profits or requiring the service provider to bear a share of net losses , without regard to whether the service provider pays expenses with respect to the operation of the managed property without reimbursement by the qualified user . These types include compensation that is ( i ) based solely upon a capitation fee , a periodic fixed fee , or a per-unit fee , ( ii ) qualitative incentive compensation , or ( iii ) any combination of ( i ) and ( ii ).
Compensation based upon a percentage of gross revenue , which was specifically authorized under prior IRS guidance , is not mentioned under Rev . Proc . 2017-13 . Nevertheless , compensation based upon a percentage of gross revenue may fit within Rev . Proc . 2017-13 , but only if the totality of the facts do not result in a sharing of net profits and the service provider does not bear the burden of sharing net losses from the operation of the managed property .
• Deferral of payment of compensation . Deferral of payment of compensation due to insufficient net cash flows from the operation of the managed property is permitted if the management contract ( i ) requires payment of compensation at least annually ; ( ii ) imposes reasonable consequences for late payment ( e . g ., reasonable interest charges or late payment fees ); and ( iii ) requires payment of the deferred compensation and interest / fees within five years of the original due date .
Control over Managed Property
In order to satisfy the safe harbor , the qualified user must exercise a significant degree of control over the use of the managed property . This will be satisfied if the management contract requires the qualified user to approve the annual budget for the managed property , capital expenditures with respect to the managed property , and the general nature and type of use of the managed property ( e . g ., the type of services ).
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