United States: Federal Jury Issues Taxpayer-Favored Ruling in Whole Hospital Joint Venture

On remand from the Fifth Circuit, a federal District Court jury has ruled for a second time that St. David’s Healthcare System, Inc. did not lose its tax-exempt status by participating in a whole hospital joint venture with a for-profit entity. The case is St. David’s Healthcare System, Inc. v. United States, W.D. Tex., No. 101CV-046, March 4, 2004.

St. David’s entered into a partnership with HCA, Inc., a for-profit entity. The aggregate ownership interest of St. David’s (as both limited and general partner) was 45.9 percent, with HCA entities holding the remaining 54.1 percent. HCA served as the general and managing partner, St. David’s had the authority to appoint the Chairman and to remove the partnership’s CEO, and the partnership’s governing board was split 50-50 between HCA and St. David’s. The IRS determined that St. David’s had ceded control of the partnership and thus was not acting exclusively in furtherance of its charitable purposes. Accordingly, it revoked St. David’s tax-exempt status, retroactive to when it first contributed its assets to the partnership. In its initial decision, the District Court found the IRS to be in error and issued a summary judgment in favor of St. David’s.

The 5 th Circuit Court of Appeals indicated that the key factor is who controls the organization. It noted that if for-profit partners "have either formal or effective control, [the court] will presume that the organization furthers the profit-seeking motivations of [that party]," but that if the non-profit partner retains control of the joint enterprise, the presumption will be that the partnership does primarily further tax-exempt purposes. These factual questions had not been answered, so the Court of Appeals was uncertain as to whether St. David’s had ceded control to HCA. Accordingly, it vacated the District Court’s initial summary judgement and sent the case back to the District Court for further proceedings to determine these factual questions. On remand, the District Court jury again ruled in favor of St. David’s, finding that it retained its tax-exempt status and was entitled to a refund of taxes assessed by the IRS.

The facts relating to an entity’s structure and operation must be closely examined in joint venture cases. It should be noted that the District Court’s second ruling was a jury verdict issued without explanation, and that the jury’s determination was based on the particular facts and circumstances of the case. Accordingly, it cannot be said that the authority to appoint the chairman or to remove the CEO will in all cases be sufficient to preserve tax exempt status, notwithstanding 50-50 governing board control. It is clear that important questions remain from the 5th Circuit’s earlier decision.

While the District Court jury ruled in favor of the exempt entity, the 5th Circuit’s decision strongly supports the IRS’ guidelines set forth in Rev. Rul. 98-15. The St. David’s case does, however, provide a measure of comfort to participants in joint ventures involving tax-exempt entities, demonstrating that, at least under certain circumstances, an exempt entity can participate in such ventures without losing tax-exempt status, even where there is a 50-50 board.

Finally, it should be noted that St. David’s involved the extreme situation of a whole-hospital joint venture. It did not present the court with an opportunity to address the issue of whether a non-profit jeopardizes its tax-exempt status or generates unrelated business taxable income by participating in an ancillary joint venture where it has a less substantial portion of its assets committed to the venture. Nor has the IRS provided further guidance on that issue. Hopefully, the IRS will issue additional guidance on these issues, both to provide a clearer sense of how such transactions should be structured and so that exempt entities will not be forced to litigate to get the IRS to acknowledge their continued tax exempt status. In the meantime, the issue of what is deemed "control" will continue to be a key issue in the negotiation of such joint ventures. 

This article is presented for informational purposes only and is not intended to constitute legal advice.