Joint Ventures with For-Profit Entities
The Internal Revenue Service recentlyprevailed in a major tax court case involving a nonprofit health systemthat entered into a joint venture with a for-profit business.
RedlandsSurgical Services was a nonprofit public benefit corporation and awholly owned subsidiary of Redlands Health Systems that entered into ajoint venture with a for-profit entity. In their opinion, Redlands Surgical Services vs. Commissioner,the United States Tax Court found that Redlands Surgical Center "hadceded effective control over the operations of the partnerships and thesurgery center to private parties, conferring impermissible privatebenefit. [Redlands Surgical Services] is therefore not operatedexclusively for exempt purposes within the meaning of Section 501(c)(3)of the Internal Revenue Code."
When structuring joint ventureswith for-profit entities, nonprofits should be certain to take carewith respect to the examples outlined in Revenue Ruling 98-15. Includedin that ruling are examples from the Internal Revenue Serviceillustrating both "good" joint ventures and "bad" joint ventures.
Thelesson learned from the Redlands case points to a number of criticalfactors that must be present for the joint venture to be considered taxexempt. First and foremost, the exempt organization must retain controlover the joint venture through voting rights and the language in thePartnership Agreement. Second, the joint venture must have as itsprimary motive to benefit the community, rather than to earn a profit.Longterm management contracts with the for-profit partner with optionsto extend indefinitely would indicate a profit motive for thefor-profit partner. Finally, documentation outlining the exemptorganization’s purpose and agenda should be kept.
The purposeand activities supporting the purpose must be discussed at all boardmeetings and must outweigh the interest of the for-profit entity. Theopinion of the court can be viewed at www.ustaxcourt.gov.
