113 T.C. 47 (T.C. 1999), 11025-97X, Redlands Surgical Services v. Commissioner of Internal Revenue

Docket Nº:11025-97X
Citation:113 T.C. 47, 113 T.C. No. 3
Opinion Judge:THORNTON, JUDGE:
Party Name:REDLANDS SURGICAL SERVICES, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent
Attorney:James L. Malone III and Robert C. Louthian III, for petitioner. Joan Ronder Domike and Elizabeth Purcell, for respondent.
Judge Panel:Thornton, Michael B.
Case Date:July 19, 1999
Court:United States Tax Court
 
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113 T.C. 47 (T.C. 1999)

113 T.C. No. 3

REDLANDS SURGICAL SERVICES, Petitioner

v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

No. 11025-97X

United States Tax Court

July 19, 1999

Decision will be entered for respondent.

SYLLABUS

P is a nonprofit corporation. Its sole activity is participating as co-general partner with a for-profit corporation in a partnership that is general partner of an operating partnership that owns and operates an ambulatory surgery center. Held: On the facts involved herein, P has ceded effective control over the operations of the partnerships and the surgery center to private parties, conferring impermissible private benefit. P is therefore not operated exclusively for exempt purposes within the meaning of sec. 501(c)(3), I.R.C. 1986.

James L. Malone III and Robert C. Louthian III, for petitioner.

Joan Ronder Domike and Elizabeth Purcell, for respondent.

Thornton, Michael B.

OPINION

THORNTON, JUDGE:

Petitioner brought this action for a declaratory judgment, pursuant to section 7428 and Title XXI of this Court's Rules. Petitioner requests the Court determine the correctness of respondent's adverse determination with respect to its initial qualification as a tax-exempt organization under section 501(c)(3). [1] The parties have submitted this

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case fully stipulated under Rule 122 on the basis of the pleadings and the stipulated administrative record, which is incorporated herein bye this reference.

FINDINGS OF FACT

Petitioner is a California nonprofit public benefit corporation with its principal place of business in Redlands, California. It is a wholly owned subsidiary of Redlands Health Systems, Inc. (RHS), a California nonprofit public benefit corporation that has been recognized as exempt under section 501(c)(3) of the Code and as a public charity within the meaning of section 509(a). RHS is the parent corporation of three subsidiaries in addition to petitioner, namely Redlands Community Hospital (Redlands Hospital) and Redlands Community Hospital Foundation (Redlands Foundation), both of which are California nonprofit public benefit corporations that have been recognized as exempt under section 501(c)(3); and Redlands Health Services, a for-profit corporation.

As described in more detail below, and as reflected schematically in the appendix hereto, in 1990 RHS became co-general partner with a for-profit corporation, Redlands-SCA Surgery Centers, Inc. (SCA Centers), in a general partnership formed to acquire a 61- percent interest in an existing outpatient surgical center in Redlands, California, two blocks from the Redlands Hospital facility. This general partnership in turn became sole general partner in the California limited partnership that owns and operates the surgical center. Under a long-term management contract, SCA Management Co. (SCA Management) -- a for-profit affiliate of SCA Centers -- manages the day-to-day operations of the surgical center, in return for a percentage of gross revenues. Several months after forming the general partnership, RHS formed petitioner to succeed to its interest in it.

Petitioner has no activity other than its involvement with the partnerships. The question is whether petitioner is operated exclusively for exempt purposes within the meaning of section 501(c)(3). We hold that it is not.

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Redlands Hospital

Since its founding in 1929, Redlands Hospital has been recognized by respondent as a charitable organization described in section 501(c)(3) and as a " hospital" described in section 170(b)(1)(A)(iii). Its mission includes providing necessary medical care free of charge, or at a discount, to individuals without insurance or other means of paying.

Redlands Hospital has its own outpatient surgery program within the hospital facility. It also maintains a 24-hour emergency room that provides emergency medical services for all patients regardless of their ability to pay. It maintains an open medical staff and is governed by a community-based board of directors. It does not discriminate on the basis of race, gender, age, color, national origin, or disability.

Inland Surgery Center, L.P.

Since its inception in 1983, the Inland Surgery Center Limited Partnership (the Operating Partnership) has operated a freestanding ambulatory surgery center (the Surgery Center) in a 12,000-square foot building within two blocks of Redlands Hospital. During the 1980's, the Operating Partnership was a successful for- profit venture, serving only surgical patients who were able to pay, by insurance or otherwise. Prior to its affiliation with the General Partnership, the Operating Partnership comprised Beaver Medical Clinic, Inc., and some 30 physician partners, who were also physicians on the medical staff of Redlands Hospital.

The Affiliation of Redlands Hospital With the Surgery Center

Before 1990, Redlands Hospital desired to increase its outpatient surgery capacity but lacked the capital resources and experience to develop and operate its own freestanding outpatient facility. In addition, such a facility would have been in competition with the existing Surgery Center, and there was concern that the Redlands community could not sustain both.

On March 1, 1990, RHS and SCA Centers entered into a general partnership agreement to acquire jointly a 61-percent general partnership interest in the Surgery Center. [2] The

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partnership is known as Redlands Ambulatory Surgery Center (the General Partnership).

SCA Centers is a for-profit, wholly owned subsidiary of Surgical Care Affiliates, Inc. (SCA), a publicly held corporation based in Nashville, Tennessee, and specializing in owning and managing ambulatory surgery centers. [3] Prior to formation of the General Partnership, neither SCA nor any of its affiliated entities had any relationship, contractual or otherwise, with RHS or any of its affiliated entities, or with the Surgery Center.

RHS contributed $ 1,131,289 to the General Partnership, borrowing $ 796,829 from SCA and the balance of $ 334,460 from Redlands Hospital. SCA Centers contributed $ 1,946,993 in cash and stock to the General Partnership. In return for its approximately 37-percent capital investment, RHS received a 46-percent interest in profits, losses, and cash-flows of the General Partnership. In return for its approximately 63-percent capital investment, SCA Centers received a 54-percent interest in profits, losses, and cash-flows of the General Partnership.

The General Partnership agreement provides in relevant part:

AGREEMENT OF GENERAL PARTNERSHIP OF REDLANDS AMBULATORY SURGERY CENTER

This AGREEMENT OF GENERAL PARTNERSHIP, [is] entered into as of the 1st day of March, 1990, by and between REDLANDS-SCA SURGERY CENTERS, INC., a California corporation (" SCA Centers" ) and a wholly owned subsidiary of Surgical Care Affiliates, Inc. (" SCA" ) * * *, RHS Corp., (" RHS" ) a California not-for-profit corporation, * * * and Redlands Community Hospital, a California not-for-profit corporation (the " Hospital" ). SCA Centers and RHS are collectively referred to as " Partners."

WITNESSETH:

WHEREAS, RHS desires to insure the availability of high quality health services in the most cost effective setting in which such services can be rendered; and

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WHEREAS, the use of an ambulatory surgical center by the area-wide residents will contribute to RHS's corporate goal of providing comprehensive health care services at an affordable price; and WHEREAS, SCA is a corporation that is engaged in the development and management of ambulatory surgical centers and has the expertise necessary to operate ambulatory surgical centers; and WHEREAS, RHS and SCA Centers desire to enter into a Partnership to be equally controlled by representatives of the Partners.

NOW, THEREFORE, in consideration of the mutual covenants herein contained, SCA Centers and RHS agree to be partners in a general partnership (the " Partnership" ) pursuant to the California Uniform Partnership Act (the " Act" ) on the terms and conditions hereinafter set forth.

1. Name and Purpose.

(a) The Partnership shall be carried on under the name of Redlands Ambulatory Surgery Center or such other name as may be selected by the Managing Directors. The Partnership has been formed to acquire a 61 percent general partner interest (the " General Partner Interest" ) in a California limited partnership (the " Operating Partnership" ) which owns and operates a freestanding ambulatory surgery center in Redlands, California known as the Inland Surgery Center (the " Center" ). The Partnership may engage in any and all other activities as may be necessary, incidental or convenient to carry out the business of the Partnership as contemplated by this Agreement.

* * * * * * *

3. Term. The Partnership shall commence on April 30, 1990, or such later date as the Partners shall mutually agree, and shall continue until March 31, 2020, or such other date as the partners shall mutual [sic] agree.

4. Management.

(a) General Management by the Managing Directors. The general management and determination of all questions relating to the affairs and policies of the Partnership, except for questions relating to the medical standards and medical policies of the centers, shall be decided by a majority vote of the Managing Directors. The Managing Directors shall consist of four (4) persons, two (2) of whom shall be chosen by SCA Centers and two (2) of whom shall be chosen by RHS. Notwithstanding the above, it is recognized that the Managing Directors have no authority to amend the Partnership Agreement. In the event the Managing Directors are unable to agree on a matter, either Partner may institute the...

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