26th Annual Health Sciences Tax Conference

Transcription

1 26th Annual Health Sciences Tax Conference Mergers, acquisitions and joint ventures: tax issues December 5, 2016

2 Disclaimer EY refers to the global organization, and may refer to one or more, of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young LLP is a client-serving member firm of Ernst & Young Global Limited operating in the US. This presentation is 2016 Ernst & Young LLP. All rights reserved. No part of this document may be reproduced, transmitted or otherwise distributed in any form or by any means, electronic or mechanical, including by photocopying, facsimile transmission, recording, rekeying, or using any information storage and retrieval system, without written permission from Ernst & Young LLP. Any reproduction, transmission or distribution of this form or any of the material herein is prohibited and is in violation of US and international law. Ernst & Young LLP expressly disclaims any liability in connection with use of this presentation or its contents by any third party. Views expressed in this presentation are those of the speakers and do not necessarily represent the views of Ernst & Young LLP. This presentation is provided solely for the purpose of enhancing knowledge on tax matters. It does not provide tax advice to any taxpayer because it does not take into account any specific taxpayer s facts and circumstances. These slides are for educational purposes only and are not intended, and should not be relied upon, as accounting advice. Page 2

3 Presenters Steven Hurst CHRISTUS Health Irving, Texas Erik Reynolds Ernst & Young LLP Denver, Colorado Ken Garner Ernst & Young LLP Fort Worth, Texas Steven Rutti Ernst & Young LLP Phoenix, Arizona Page 3

4 Agenda Introduction Current market conditions Mergers and acquisitions International expansion Tax issues Mergers and acquisitions by nonprofits Accountable care organizations (ACOs) Joint ventures Page 4

5 Mergers and acquisitions Introduction Forms of hospital consolidations and acquisitions: Joint ventures (JVs) Joint operating agreements (JOAs) Affiliations Asset acquisitions Mergers Page 5

6 Joint ventures are an important strategic alternative in health care Over 150 large health care JVs have been recorded in the last five years. Due to a lack of formal reporting requirements for JVs, this probably greatly understates the actual number. For example, none of the JVs EY has worked on show up in the Capital IQ database used for this chart. Number of recorded health care joint ventures Source: Capital IQ database The 2016 Capital Confidence Barometer survey of health care executives indicates JVs will be nearly as prevalent as acquisitions. 56% expect to actively pursue acquisitions in the next 12 months 50% plan to enter into a JV or alliance with other companies in the next 12 months If you want to end up owning either a piece or the majority of really highquality assets that are going to be transformative in a market, that s going to increasingly require a JV approach. Trevor Fetter, Tenet CEO Number of joint ventures Page 6

7 Powerful mutual benefits are encouraging the formation of at least six types of JVs JV type Benefits to partner one Benefits to partner two Examples Brand leverage (brand owner/local providers) Monetization of the power of the brand Make cutting-edge services more broadly available More volume from brand affiliation Training of local physicians Duke/Life Point Mayo Clinic/multiple hospitals Cleveland Clinic/multiple hospitals Service expansion (hospital chain/specialty provider Expansion of the continuum of care to more profitable outpatient model New services Partner with operational expertise, scale and full-service hospitals Cash Tenet and USPI Tenet and Baylor Scott & White Capital infusion (hospital chain/community hospital) Additional patients through regional expansion Referrals from regional hospitals to medical centers when necessary Capital investment Operations improvements Scale in pricing and procurement Tenet/Baptist Health Carondelet Health (Tenet, Dignity, Ascension) Population health management (provider/payer) Additional volume Better coordination of care Information sharing on population health Better manage health of covered lives, improve provider utilization and smarter pricing Information sharing on population health Vivity (Anthem/multiple SoCal health systems) Innovation Health (Aetna/Inova) International expansion (US leader/less developed market Local partner to navigate regulatory requirements Growth through new markets Operational expertise of world-class provider Investments in local infrastructure CHRISTUS Health/South and Central America Cigna/TTK Group DaVita/Malaysian gov t Process outsourcing (provider/process specialist) Elimination of troublesome admin Lower costs through scale and enhancements to process Ownership in outsource provider Initial customers bring basic process and systems, initial volume and credibility Optum360 (Dignity Health/UHG) Page 7

8 Mergers and acquisitions (international expansion) at CHRISTUS Health Page 8

9 Why CHRISTUS expanded internationally Extend company mission Diversify Increase long-term sustainability Develop new worldwide health care model Page 9

10 Chile US CHRISTUS US Chile CHRISTUS Chile Royalties Management service fees Joint Venture Health Care Provider Page 10

11 Colombia CHRISTUS US CHRISTUS US Investor Royalties US Colombia CHRISTUS Colombia Management service fees Joint Venture Health Care Provider Page 11

12 Mexico US Mexico CHRISTUS US Joint Venture Health Care Provider Royalties Page 12

13 Things to consider Business goals Expansion Net operating income contribution Investment structure Return on investment strategies Page 13

14 Investment structure Partnership vs. acquisition vs. organic expansion Legal structure Debt vs. equity Page 14

15 Return on investment strategies Management fees License fees Dividends Page 15

16 Other considerations Exit strategy Reporting considerations Transfer pricing Intercompany activities Unrelated business income (UBI) Indirect taxes Supporting investment structure (back office) Staffing Expats vs. local hires Page 16

17 Tax issues Page 17

18 Joint ventures In a joint venture, two or more nonprofit organizations lend their efforts, assets and expertise in order to carry out a common purpose. The organizations involved may form a new entity (such as a limited liability company, partnership or nonprofit corporation) to carry out the endeavor. The new entity may receive tax-exempt status if it is organized and operated for exempt purposes. Generally, however, organizations commit certain resources to a joint venture without forming a new entity. The rights and obligations of the parties are spelled out in an agreement. Page 18

19 Joint ventures Potential tax issues If venture is formed as a nonprofit corporation: Exempt status and public charity status If venture is formed as a partnership between two or more exempt organizations: Generally should not affect exempt status or result in unrelated business taxable income (UBTI) There are a number of Private Letter Rulings (PLRs) addressing partnerships between two health care-related exempt organizations PLRs , , , , If the venture is formed as a partnership between an exempt organization and a for-profit organization: Exempt status UBI This topic will be discussed later in the presentation Page 19

20 Joint operating agreements Concept: Contractual arrangements for the integration of two or more health care systems JOAs are often referred to as virtual mergers as this model is used to integrate operations of unrelated hospital systems without transferring assets. The JOA itself will outline the intended legal relationship between the parties; will address various governance, management and financial issues; and will contain termination provisions. Structural characteristics A JOA is typically accomplished by forming a new corporation, known as a joint operating company (JOC), which is formed to serve as the parent to two or more unrelated hospitals (or systems). Existing hospital corporations and boards generally remain intact with certain powers that may still be exercised. Page 20

21 Joint operating agreements Structural characteristics (cont.) Goals Generally, the assets of the existing hospital corporations stay with those hospitals. The JOC (i.e., the new, nonprofit corporation) is given considerable management and financial authority over the whole enterprise. Establish clinically integrated networks Coordinate services to improve patient care Increase efficiencies Eliminate or avoid duplicative services Page 21

22 Tax issues associated with a JOA arrangement Tax issues: Whether the JOA generates UBI to its participants from services provided by the super parent or payments between one hospital to another hospital If a new parent is formed, whether that entity qualifies for exemption Focus is on control by the new JOA parent (sometimes referred to as a JOC or contractually through the JOA, if no new parent is formed JOA must establish the equivalent of a parent-subsidiary relationship between the participants Internal Revenue Service (IRS) looks for explicit manifestations of control under all facts and circumstances of a JOA between unrelated hospitals such that the dealings under the JOA are merely matters of accounting between related organizations rather than rising to the level of unrelated trade or business activity Page 22

23 Factors considered by the IRS The IRS applies a flexible control analysis that does not rely on structural control or any one factor, but instead it relies on a preponderance of facts and circumstances that demonstrate that significant control over management and financial decisions has been ceded by the parties to a mutual governing body under a JOA or a super parent. Factors: Delegation of significant authority over participating entities Permanence Veto power Reserved powers Page 23

24 Factor 1: Delegation of significant authority over participating entities JOA governing body should have the power to: Establish budgets Establish strategic plans Monitor and audit each participating entity s compliance with its directives Approve debt Approve capital transactions Reallocate income among entities to assure financial integration Page 24

25 Factor 2: Permanence A temporary relationship does not look like a parentsubsidiary relationship. Is there glue to hold the parties together through disputes? E.g., arbitration or other dispute resolution Are there disincentives to voluntary termination? E.g., penalties for walking Page 25

26 Factors 3 and 4: Veto rights and limited reserve powers Factor 3: Veto rights JOA governing body exercises control, not just veto power, over participants Participating hospitals and entities have limited ability to veto JOA governing body decisions Factor 4: Limited reserve powers Retention of certain reserved powers by participating hospitals will not preclude finding that JOA has established the equivalent of a parent-subsidiary relationship (e.g., authority over ethical or moral issues based on religious principles may be reserved by participating entities) Page 26

27 Exemption issue New JOA parent may be considered to be carrying out an integral part of the activities of the network hospitals. Integral part basis for exemption An otherwise properly organized and operated organization can derivatively qualify for exemption under Section 501(c)(3) as an integral part if it: Performs essential services for an exempt organization and the services, if performed by the exempt organization directly, would not be an unrelated trade or business Exercises sufficient control and close supervision, based on all the facts and circumstances, to establish the equivalent of a parentsubsidiary relationship Page 27

28 Benefits of JOA arrangements It allows the hospital participants to share the financial risks and rewards of providing key health care services to the community and otherwise develop a closely integrated regional health care delivery network. The assets of hospital participants remain and are not transferred. Network participants effectively accomplish financial integration through annual payments between and among hospitals based on a weighted average of ratios specified in the JOA (for example, metrics based on net assets, net income, net cash flow and/or capital expenditures). Page 28

29 Benefits of JOA arrangements A JOA will not alter the bond obligations for any of the underlying hospital facilities, and the bonds for each facility continue to qualify as qualified hospital bonds under Section 145(c). Page 29

30 Affiliations Fact pattern One exempt organization becomes the parent of another health care system The acquiring nonprofit becomes the sole member of the target health care system and/or the acquiring nonprofit has the right to determine the board of directors of the acquired health care system Member substitution Usually there is some type of affiliation agreement between the acquiring nonprofit and the acquired health care system Variation of this structure Formation of a new nonprofit corporation that becomes the sole member (or parent) of the existing nonprofit corporations Page 30

31 Asset acquisitions Fact pattern An exempt organization purchases all the assets of one or more exempt organizations or taxable corporations Tax issues: Acquiring entity Generally no tax consequences Target If an exempt organization: Generally such a sale will not adversely impact exempt status or result in UBTI For example: PLR (IRS ruled that transferring organization will continue to qualify under Section 501(c)(3) and that the sale of assets will not give rise to unrelated business taxable income under Sections 511 through 514); see also PLR (sales of assets as a one-time activity and not regularly carried on) If taxable corporation: Generally a taxable event to target Page 31

32 Acquisitions of for-profit corporations by exempt organizations Generally structured as either asset purchase or stock purchase Post acquisition: Remember that stock ownership of a taxable corporate subsidiary can result in tax consequences with respect to subsequent liquidation or conversion to exempt status Section 337 treats as a taxable event the following: Conversion of a for-profit subsidiary into a tax-exempt organization Liquidation of a for-profit subsidiary into the tax-exempt parent Section 337 applies when a taxable corporation transfers all or substantially all of its assets to a tax-exempt organization Under Section 337, the for-profit organization must recognize gain or loss as if the assets were sold at fair market value. Page 32

33 Mergers Definition One corporation (acquired corporation) merges into the other corporation (the surviving corporation). The acquired corporation ceases to exist. All assets and liabilities of the acquired corporation become assets and liabilities of the surviving corporation by operation of law. Common characteristics: Generally, this type of transaction is cashless. Future capital commitments, other funding requirements and assumption of liabilities are common consideration components. Page 33

34 Mergers Tax issues raised: Whether the surviving organization or organizations involved can, after the transaction, retain tax-exempt status Whether these surviving organizations can retain public charity status Whether the organizations in the transaction can avoid the tax on UBTI There are a number of PLRs addressing tax consequences of a merger between exempt organizations. Generally, the merger of one exempt organization into another exempt organization: Does not adversely impact the exempt status of the surviving entity The assets and income transferred in the merger remain dedicated to charitable purposes. Does not generate UBI Page 34

35 Other considerations Regulatory approval State attorney general approval Due diligence Legal and financial diligence on each other s organization Financial diligence typically includes operating trends, quality of earnings, debt-like items, capital expenditure needs and net asset considerations Other key due diligence areas include taxation, coding/compliance, reimbursement, payer contracting, physician strategy, information technology, insurance and risk management, legal and human resources (including employee benefits) Diligence is typically a 60- to 90-day process Page 35

36 Tax due diligence matters Income tax Federal State Other taxes Sales and use Property Payroll (worker classification) Excise Tax-exempt bonds Page 36

37 Post transition tax issues Reporting to IRS Final returns Integration Public charity status Compensation and benefits Group rulings Policies and procedures 501(r) Conflict of interest policies Transfer pricing Tax-exempt debt For-profit/nonprofit consolidation Page 37

38 ACOs Introduction What is an ACO? ACOs are groups of doctors, hospitals, other health care providers and third-party payers, who come together voluntarily to give coordinated high-quality care to their patients. The goal of coordinated care is to ensure that patients get the right care at the right time, while avoiding unnecessary duplication of services and preventing medical errors. When an ACO succeeds both in delivering high-quality care and wisely spending health care dollars, it will share in the savings it achieves. Page 38

39 ACOs Introduction Today, there are roughly 800 ACOs in operation for Medicare, Medicaid and commercial populations serving 28.3 million people across the US. Medicaid ACOs To date, 10 states have launched Medicaid ACO programs and 6 more are actively pursuing them. States with active Medicaid ACO programs: Colorado, Illinois, Maine, Minnesota, New Jersey, New York, Oregon, Rhode Island, Utah and Vermont Page 39

40 ACOs Introduction Medicare offers several ACO programs: Medicare Shared Savings Program (MSSP) A program that helps a Medicare fee-for-service program providers become an ACO Advance Payment ACO model A supplementary incentive program for selected participants (physician-based and rural providers) in the Shared Savings Program Pioneer ACO model A program designed for early adopters of coordinated care; no longer accepting applications Next Generation ACO Model This initiative was launched in 2015 and the program builds on the successes of earlier ACO initiatives Statistics (source: Centers for Medicare & Medicaid Services (CMS) website) Currently 433 MSSP ACOs Currently 35 Advance Payment ACOs Currently 9 Pioneer ACOs Currently 18 Next Generation ACOs Page 40

41 ACOs Introduction Legal structures of ACOs Single-member limited liability companies (LLCs) LLCs or partnerships Corporations For-profit and nonprofit Driving tax issues Furthering exempt purposes Unrelated business income Page 41

42 ACOs IRS guidance on Notice General principles Participation in the MSSP through an ACO furthers taxexempt purposes by lessening the burdens of government. Control by an exempt organization (EO) is not required in order for an ACO that participates in the MSSP to further its charitable purposes. Shared savings income of EO participants from an ACO s participation in the MSSP will not be UBI. Serving Medicaid or indigent populations through an ACO will generally further charitable purposes of relief for the poor and distressed. Page 42

43 ACOs IRS guidance on Notice Avoiding private benefit and inurement The Notice identifies five factors to be considered: The terms of the EO s participation in the MSSP through the ACO must be set forth in advance in a written agreement negotiated at arm s length. The CMS has accepted the ACO into, and has not terminated the ACO from, the MSSP. The EO s share of economic benefits derived from the ACO is proportional to the benefits or contributions the EO provides to the ACO. The EO s share of the ACO s losses does not exceed its share of the ACO s economic benefits. All contracts and transactions entered into by the EO with the ACO and the ACO s participants, and by the ACO with the ACO s participants and any other parties, are at fair market value (FMV). Page 43

44 Exemption considerations for exempt organizations participating in ACOs The general principles applicable to other Section 501(c)(3) organizations apply to ACOs seeking tax exemption. Substantial non-exempt activities will jeopardize exemption. Private benefit and private inurement are prohibited. ACOs formed as joint ventures (i.e., partnerships) are subject to the guidance in Revenue Rulings and Page 44

45 ACOs conducting non-mssp activities Notice does not address whether non-mssp activities through an ACO will be consistent with the Section 501(c)(3) exemption or result in UBI. However, the IRS indicated: For ACOs that enter into shared savings arrangements with other types of health insurance payers (non-mssp): This is unlikely to lessen the burdens of government. Certain non-mssp activities may further an exempt purpose. For example, ACOs may also participate in shared savings arrangements with Medicaid, which may further the charitable purpose of relieving the poor and distressed or the underprivileged. Negotiating with private health insurers on behalf of unrelated parties generally is not a charitable activity regardless of whether the agreement negotiated involves a program aimed at achieving cost savings in health care delivery. Page 45

46 ACOs IRS denial of 501(c)(3) status (PLR ) First IRS guidance regarding ACOs that do not participate in MSSP ACO formed a clinically integrated network of health care providers (both system-employed and independent providers) to further the Triple Aim reform goals of the ACA: Reducing cost of health care for individuals Improving patient access to care and quality of care Improving population health and patient experience ACO did not provide health care services ACO acted as the representative for all participating providers in the negotiation and execution of certain agreements with thirdparty payers Page 46

47 ACOs IRS denial of 501(c)(3) status (PLR ) IRS denied 501(c)(3) exemption because ACO negotiated agreements between payors and providers not affiliated with the ACO s health system IRS noted that this activity is not a charitable activity IRS stated that this activity conferred an impermissible private benefit to providers not affiliated with the health system IRS also noted that ACO would not have qualified as a supporting organization, so it would have been classified as a private foundation if exempt Page 47

48 Joint ventures (treated as a partnership for tax purposes) Limited and general partnerships or LLCs treated as a partnerships for tax purposes The term joint venture has no precise legal definition: For our purposes, this term refers to arrangements in which a tax-exempt health care organization and one or more taxable, for-profit parties have agreed to provide capital or services in a common undertaking and to share in some manner the income or losses from the venture. Two general categories: Whole hospital or whole entity joint ventures exist when a tax-exempt entity contributes all or substantially all of its assets to a joint venture entity in partnership with a for-profit entity that also contributes cash and/or assets. Ancillary joint ventures involve an insubstantial portion of the exempt entity s assets and activities. Page 48

49 Overview of joint ventures A tax-exempt health care organization may permissibly engage in a joint venture with for-profit parties, including physicians, without putting its exemption at risk, as long as the joint venture meets certain parameters. Issues: Tax-exempt status Participation in the joint venture should further the organization s exempt purposes and the arrangement should permit the organization to act exclusively in furtherance of its exempt purposes Private benefit and private inurement UBI Page 49

50 Overview of joint ventures Avoid private benefit and private inurement Each party to the joint venture should receive an interest in the joint venture that is proportionate to its contributions. Returns of capital, allocations and distributions to the participants should be proportionate to their ownership interests. All transactions between the parties and between the joint venture and the parties should be arm s length and at FMV. Page 50

51 Whole hospital joint ventures Tax issues raised: Continued tax-exempt status of the nonprofit partner Analysis: (1) Participation in the venture must further the nonprofit s exempt purposes, and (2) the arrangement must permit the nonprofit to act exclusively in furtherance of its exempt purposes. If a tax-exempt entity cedes control of partnership activities to a for-profit entity, the IRS will consider the partnership to serve private interests (of the forprofit partner), not public interests. Main guidance: Rev. Rul Redlands Surgical Services v. Commissioner, 113 T.C. 47 (1999), aff d 242 F.3rd 904 (9th Cir. 2001) St. David s Health Care System Inc. v. United States, U.S. Tax Cas. (CCH) P50452 (W.D. Tex. 2002), rev d and remanded, 349 F.3rd 232 (5th Cir. 2003) Page 51

52 Rev. Rul IRS set out its analysis of a whole hospital joint venture in Rev. Rul in the form of two fact patterns Good facts: Exempt hospital controls the joint venture and is able to ensure the venture furthers its exempt purposes Majority hospital representation on the joint venture board Governing documents required the board to satisfy the community benefit standard without regard to profit maximization Joint venture was managed by an independent party Bad facts: Hospital was not able to further its exempt purposes through participation in the venture 50/50 representation on the joint venture s board No charitable override in the governing documents Joint venture managed by an affiliate of the for-profit entity Page 52

53 Demonstrating control by the exempt partner Formal majority control Majority board control 50/50 board representation with certain reserved powers and unilateral rights Reserved powers Such powers could include approval of the following: Capital and operating budgets and variations over a specified dollar threshold Sale of assets with a value in excess of a specified dollar amount Incurrence, assumption or guarantee of debt in excess of a specified dollar threshold Dissolution, merger, consolidation or sale of all, or substantially all, of the assets Amendments of the joint venture agreement Affiliations or joint ventures with other parties Contracts with any of the for-profit parties Discontinuance of any line of service or closure or reduction in scope of operation Discontinuance of Medicare or Medicaid Appointment and removal of management of the joint venture Page 53

54 Demonstrating control 50/50 board representation with certain reserved powers and unilateral rights (cont.) Unilateral rights given to exempt partner Such rights could include: Level of charity care provided by the joint venture Ability to enter into new managed care contracts for the joint venture Unilateral ability to implement community benefit activities (e.g., new services, charity care policy, increase in charity care) Meaningful ability to terminate joint venture management agreements for cause Ability to dissolve the joint venture if continued participation jeopardizes the organization s exempt status Monitoring and audit rights to review joint venture s activities Page 54

55 Demonstrating control Charitable purposes Governing documents (including management agreements) should clearly state: The joint venture will be operated in a charitable manner consistent with the organization s exempt purposes (community benefit standard). The joint venture s charitable purposes will override profit maximization. The joint venture may not engage in activities that would jeopardize the exempt status of the exempt participant. Management agreements If the joint venture enters into a management agreement with a for-profit entity: The management agreement should not have a term longer than five years. The management agreement should require the manager to operate the facility in conformance with the joint venture s charitable purposes, and failure to comply with this requirement should be included as a basis for termination and/or non-renewal. Page 55

56 Ancillary joint ventures Examples: Patient care (clinics, surgery centers, imaging centers) Laboratory Medical office building Tax issues raised: Tax exemption Generally not at issue since the activities of the joint venture are insubstantial compared to the exempt entity s operations and activities as a whole But watch out for private benefit and inurement (i.e., non-arm s length and non-fmv transactions) Unrelated business income Will likely depend upon the extent to which the exempt organization controls the activities and operations of the joint venture (see Rev. Rul ) Page 56

57 Questions? Page 57

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