By John W. Jones, Esq.
On February 7, 2001, the Internal Revenue Service issued Private Letter Ruling 200118054 to a nonprofit health care system, approving its participation in a for-profit ambulatory surgery center (ASC) joint venture with a group of physicians. The IRS concluded that the health system’s participation in the joint venture would not jeopardize its tax-exempt or public charity status and that receipt of its share of ASC profits would not result in unrelated business income taxable to the health system for its distributive share of profits and losses. This tax guidance, together with the recently enacted safe harbors available for ASCs under the federal anti-kickback statute and Stark II regulations, should once again offer physicians and hospitals promising business venture opportunities.
IRS Private Letter Ruling
The new ruling amplifies the IRS’ 1998 opinion in Rev. Rul. 98-15, in which it approved a whole-hospital joint venture, and clarifies how a non-profit health care system can participate in an ancillary for-profit joint venture while maintaining its tax-exempt and public charity status. In this new ruling the IRS opined that a 501(c)(3) organization may participate in a partnership without jeopardizing its exempt status if (1) the partnership furthers a charitable purpose and (2) “the partnership arrangement permits the exempt organization to act exclusively in furtherance of its exempt purposes.” The control afforded to the hospital under the partnership was critical to IRS approval of the arrangement.
Several relevant facts establishing the hospital’s control of the partnership formed the basis of the ruling:
1. The partnership arrangement, here a professional limited liability company (LLC), would be managed by a board of six individuals, two of whom would be appointed by the health system and four of whom would be elected by the other members of the LLC. Each health system-appointed director would have three votes (a total of six) and all other directors would have one vote (a total of four). A majority vote would be required for all matters that come before the board, insuring the health system’s control of board decision-making.
2. The health system had control of matters involving votes of all members. The health system would own a 70 percent membership interest in the LLC and would always own at least 51 percent of the membership interests of the LLC.
3. The directors appointed by the health system would be community leaders experienced in health care matters, would not be on the medical staff of the hospital or the ASC and would not otherwise engage in business transactions with the health system.
4. The governing documents could be amended only with the approval of all members.
5. The LLC’s annual operating and capital budgets and other significant decisions would require the approval of the health system.
The ruling emphasizes that the most significant factor leading to the approval by the IRS of ancillary for-profit joint venture arrangements will be the degree of control exercised by the health system over the LLC and all decisions relating to maintenance of its charitable purpose.
The federal anti-kickback statute prohibits physicians and hospitals from knowingly and willfully, offering, paying, soliciting or receiving any remuneration in return for the referral of business reimbursable under the federal health care programs unless an exception or safe harbor is satisfied. One of the safe harbors recently enacted by the Office of Inspector General of the Centers for Medicare and Medicaid Services (CMS—formerly the Health Care Financing Administration) protects four categories of investments in an ASC, including joint investments by physicians and hospitals. The safe harbor is designed specifically to include physician investors who will also use the ASC for their own patients, because the government views the physician’s own reimbursement as incentive against any impermissible remuneration for referral to the ASC.
The physicians who partner with a hospital under this safe harbor must fall into one of three categories: surgeons, physicians engaged in the same surgical specialty or multi-specialty groups. Under the ASC safe harbor, surgeons or physicians engaged in the same surgical specialty may be investors in the ASC, if each derives at least one-third of his medical practice income from all sources for the previous fiscal year or previous 12-month period from the physician’s own performance of procedures that Medicare will cover if performed in an ASC (the “one-third practice income test”).
Investors may also include non-surgeons, provided they perform ASC procedures as a significant part of their medical practices. Where surgeons and non-surgeons invest together in an ASC, because of the increased risk of remuneration for referrals among physicians with different specialties, the surgeons and non-surgeons must meet the one-third practice income test, as well as a second standard known as the “one-third procedures test.” The one-third procedures test requires that at least one-third of the physician’s procedures that require a hospital surgical or ASC setting be performed at the ASC in which the physician is an investor. For physicians who meet both tests, the ASC truly qualifies as an extension of their medical practice. Morever, such physician investors are unlikely to have significant incentives to generate referrals for other investors because of the minimal additional return on investment derived from such referrals.
In addition to meeting these criteria, the following requirements must also be satisfied to achieve protection under the ASC safe harbor:
The terms on which an investment interest is offered to a physician or hospital investor must not be related to the previous or expected volume of referrals by the physician or hospital investor to the ASC.
The ASC or physician or hospital investor (or other individual or ASC acting on behalf of the ASC or any physician or hospital investor) must not loan funds to, or guarantee a loan for, a physician or hospital investor if such investor uses any part of such loan to obtain the investment interest.
The amount of payment to any physician or hospital investor in return for the investment must be directly proportional to the amount of capital investment (including the fair market value of any pre-operational services rendered) of such investor.
The ASC and any physician or hospital investor must treat patients receiving medical benefits or assistance under any federal health care program in a nondiscriminatory manner.
Any space, equipment or service provided by the hospital to the ASC must be pursuant to a safe harbor arrangement.
All ancillary services for federal health care program beneficiaries performed at the ASC must be directly and integrally related to primary procedures performed at the ASC, and none may be separately billed to Medicare or other federal health care programs.
The hospital may not include on its cost report or any claim for payment from a federal health care program any costs associated with the ASC (unless such costs are required to be included by a federal health care program).
The hospital may not be in a position to make or influence referrals directly or indirectly to any investor or the ASC.
Accordingly, surgeons and hospitals can invest in a surgeon/hospital-owned ASC so long as the surgeons satisfy the “one-third practice income test” under the safe harbor. If, however, non-surgeon physicians invest in the ASC, each of the physician investors not only must satisfy the “one-third practice income test” but must also satisfy the “one-third procedures test” to achieve safe harbor protection.
The Stark law is not a significant factor in evaluating ASC joint ventures in most circumstances. Generally, the Stark law prohibits a physician from making a referral to an entity with which the physician (or a family member) has a financial relationship for the furnishing of certain designated health services (DHS) that are reimbursable under the government programs. Ambulatory surgical services are not DHS and, therefore, do not implicate Stark.
Significantly, in the preamble of the recently finalized Stark II regulations (Phase I), CMS states that DHS that are included in a bundled ASC payment will no longer be considered DHS. The original safe harbor only protected clinical laboratory services furnished in an ASC where payment for those services was included in the ASC rate. The regulations also extend, under certain circumstances, safe harbor protection to implants, including, but not limited to, cochlear implants, intraocular lenses and other implanted prosthetics, implanted prosthetic devices and implanted durable medical equipment furnished in an ASC, as well as eyeglasses and contact lenses furnished to patients after cataract surgery.
The regulatory environment is now ripe for hospital-physician ASC joint venture arrangements. Compliance with applicable law is complex, especially in the non-profit arena. Close attention must be payed to various regulatory requirements.
John W. Jones, Esq., is a member of the Health Care Services Group at Pepper Hamilton LLP in Philadelphia.