Partnering nonprofit, tax-exempt entities with for-profit entities: Ninth Circuit's decision in Redlands.

• Author: Sair, Edward A.

The Ninth Circuit, in a brief per curiam opinion, affirmed the Tax Court's opinion in Redlands Surgical Services, 242 F3d 904 (2001). The Tax Court held that an exempt organization's nonprofit subsidiary, which was in partnership with a for-profit corporation, ceded control over its proposed tax-exempt activity to the for-profit corporation and therefore was not operated exclusively for exempt purposes. Caution should, therefore, be exercised when structuring any similar transactions, to take into account the analysis set forth in the Tax Court's Redlands decision.

Background

Redlands Health Systems, a holding company with subsidiaries operating hospitals, is a nonprofit, tax-exempt organization under Sec. 501(c)(3). SCA Centers and its affiliates are for-profit corporations. In 1990, Redlands Health Systems formed a partnership with SCA Centers to acquire a 61% interest in another partnership operating a surgery center. Redlands Health Systems subsequently formed Redlands Surgical Services (RSS), a nonprofit corporation, and transferred its partnership interest in the surgery center to RSS. The partnership interest was RSS's sole activity. RSS applied for a tax exemption under Sec. 501(c)(3), but the Service issued an adverse determination. RSS then brought an action for a declaratory judgment in the Tax Court, requesting it to determine the correctness of the adverse determination.

Tax Court

The IRS argued that RSS was not operated exclusively for charitable purposes because it operated for the benefit of private parties and failed to benefit a broad cross-section of the community. The Service contended that the partnership agreements and related management contract were structured to give for-profit interests control over the surgery center. Further, the surgery center was a successful, profit-making business that never held itself out as a charity or operated as a charitable healthcare provider.

RSS argued that it met the operational test because its activities surrounding the surgery center furthered its purpose of promoting health for the benefit of the Redlands community, by:

* Providing access to an ambulatory surgery center for all community members based on medical need rather than ability to pay; and

* Integrating the outpatient services of Redlands Hospital and the surgery center.

RSS said its dealings with the for-profit partners were at arm's length, and that it had sufficient influence over the surgery center's activities to...