WASHINGTON - An "on behalf of" issuer can change its status and become an independent nonprofit organization that uses tax-exempt 501(C)(3) bonds to finance hospital improvements under a ruling published this week by the internal Revenue Service.

Private letter ruling 9335040 revolves around an unidentified non-profit organization that has issued tax-exempt governmental bonds on behalf of a city since 1974 to finance a hospital and related improvements and equipment.

Nonprofit organizations have been allowed for roughly 30 years to issue tax-exempt bonds on behalf of cities or other local governments under IRS Revenue Ruling 63-20. Called "on behalf of" issuers, these nonprofit organizations act as agents for, or alter egos of, the local governments. They own and operate each project financed with the bonds. But project ownership must revert back to the local government once the bonds are redeemed.

In this case, the nonprofit organization, acting on behalf of a city, issued tax-exempt bonds in 1974 and 1983 to finance a hospital and improvements and it advance refunded the 1974 bonds in 1977.

The nonprofit organization wanted to issue more bonds for improvements to the hospital later this year.

But both the city and the nonprofit organization agreed that the general public would best be served if the nonprofit organization became the owner and operator of the hospital on a permanent basis, the IRS ruling said.

The city and the nonprofit organization proposed a transaction to change their relationship so that the nonprofit organization would stop issuing governmental bonds on behalf of the city and would, instead, begin borrowing from the city or some other bond-issuing authority as an independent nonprofit organization.

Under the proposed transaction, the city would issue bond anticipation notes and use the proceeds to immediately redeem the 1977 bonds and to defease the 1983 bonds to their first call date.

Upon defeasance of the 1983 bonds, ownership of the hospital would transfer to the city for 91 days. The city would have to hold title to the hospital for this period of time under IRS Revenue Ruling 82-26, a ruling that expands on the requirements of the 1963 revenue ruling.

Meanwhile, the city was to have published a notice of its intent to sell the hospital back to the nonprofit organization after the 91-day period. The city's voters, under state law, would have an opportunity to block the transfer of the hospital to the nonprofit organization.

During the 91-day period. the nonprofit organization would continue to hold the license for the hospital and would continue to operate it under a contract with the city. The city, however, would be able to cancel the contract three days after providing a written notice of an intent to do so.

Also during the 91 days, all contracts with doctors and leases for equipment would remain in effect as obligations of the nonprofit organization. But the city would be able to enter into its own contractual arrangements during this period.

The nonprofit organization sought the ruling after worrying that the IRS might find that the ownership had not actually been transferred to the city because the nonprofit organization continued to operate the hospital and the existing contracts remained in place during the 91 -day period.

But the IRS concluded in the ruling that the organization's continued operation of the hospital would not undermine the transfer because the city could cancel the contract at any time after three days' written notice.

The IRS also found that the-continuation of existing contracts would not jeopardize the transfer because the city was free to enter into its own contractual arrangements during the 91 -day period.

In the ruling, the IRS assured the nonprofit organization that once the proposed transaction was completed. the organization would be able to finance its project with tax-exempt 501(c)(3) bonds.

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