REORGANIZATION OF HEALTH CARE ENTITIES WILL HAVE NO ADVERSE CONSEQUENCES.

UIL Number(s) 0501.05-11

                                             Date: February 16, 1995

This is in response to letters from your authorized representative dated November 21, 1994, and February 8, 1995, requesting a series of rulings on your behalf regarding the tax consequences associated with the transactions described below.

R is exempt from federal income tax under section 501(c)(3) of the Code and is a nonprivate foundation under sections 509(a)(1) and 170(b)(1)(A)(iii). It is currently licensed to operate 600 inpatient hospital beds at two locations as well as a skilled nursing facility. It also operates community based radiology and rehabilitation outpatient centers and primary care clinics and conducts several comprehensive research programs. It is a major teaching affiliate of a state university and maintains accredited residency programs in several medical specialties. It is controlled by a board of directors composed of civic leaders and consistent with the size and nature of its facilities, admitting privileges are available to qualified physicians in the area who apply for them. It operates a full-time emergency room open to all persons regardless of their ability to pay, participates in a nondiscriminatory fashion in the Medicare and Medicaid programs and renders meaningful charity care to the community, including primary health care centers aimed specifically at the needs of socioeconomically disadvantaged and minority groups.

S is exempt from federal income tax under section 501(c)(3) of the Code and is a nonprivate foundation under sections 509(a)(1) and 170(b)(1)(A)(vi). It performs fundraising activities and administers grants benefitting R and its tax-exempt affiliates. Its sole member is an unincorporated association comprised of its directors and the directors of R.

T is exempt from federal income tax under section 501(c)(3) of the Code and is a nonprivate foundation under sections 509(a)(1) and 170(b)(1)(A)(iii). It currently operates a freestanding ambulatory surgery center. R is the sole corporate member of T.

U is exempt from federal income tax under section 501(c)(3) of the Code and is a nonprivate foundation under section 509(a)(2). It operates an adult day care center and also acts as the sub-parent of several other entities in the current corporate system. R is the sole corporate member of U.

V is exempt from federal income tax under section 501(c)(3) of the Code and is a nonprivate foundation under section 509(a)(2). It operates a certified home health agency and a long-term home health care program licensed by the state department of health. U is the sole corporate member of V.

W is exempt from federal income tax under section 501(c)(3) of the Code and is a nonprivate foundation under section 509(a)(3). It benefits and supports U, which is its sole corporate member.

X is exempt from federal income tax under section 501(c)(2) of the Code. Its primary activity to date has been to construct a building occupied by U and W, which contributed and loaned funds to it to finance that project.

The corporate reorganization includes the creation of Q which has filed an application for recognition of exemption from federal income tax under section 501(c)(3). Once Q obtains tax-exempt and nonprivate foundation status, the bylaws of R, S and T will be amended to make Q the sole member of each of them. A similar amendment to the bylaws of U will be contingent upon approval by the state public health council, which you anticipate will be routine but could take a year or more to obtain given that agency's workload. In its capacity as sole member of R, S, T and U, Q will be empowered under state non-profit corporation law to appoint each of their Boards of Directors, amend their Certificates of Incorporation and Bylaws, and approve certain extraordinary corporate transactions such as mergers, dissolution and liquidation. The entities that are currently subordinate to U will continue their current relationships, and U will continue to exercise similar statutory powers with respect to them.

As the parent holding company of R, S, T and U, Q will monitor and guide the activities of those entities and any other tax exempt affiliates of Q formed in the future in order to foster the provision of high quality health care services to the community through the most economical, efficient, coordinated system possible. You anticipate that R, S, T and U and each of the other exempt affiliates will continue to perform their respective exempt functions, although Q will study whether new organizations should be created either to assume some of the functions performed by R, S, T and U or other affiliates that may then exist, or to add new services to the overall system.

You expect that by providing a centralized focus and ongoing coordinated oversight of the resulting multi-entity health care delivery system, Q will enable that system to respond more effectively to the increasingly competitive environment and decreasing reimbursement and other resources which R, S, T and U are currently confronting. The holding company structure which will result from the reorganization will provide the flexibility to cope with this environment and to allocate resources and plan effectively for the future by pulling together new and existing affiliates into a planned and coordinated system. Q's system-wide perspective will enable it to study and respond to the community's health care needs in a more effective manner than could be achieved by any of the affiliates acting alone. Other goals will be to promote more effective use of specialized services and expertise by avoiding unnecessary duplication and realizing economies of scale through the sharing of assets, services and/or personnel among the affiliates. In addition, Q and the resulting holding company structure will foster organizational efficiency by systematizing relationships through standardized membership and board structures and will help to define the particular responsibilities of the affiliates and allow them to more precisely focus on their respective areas of expertise. In the future, the holding company structure will facilitate the separation of nonregulated activities from those which are regulated by government agencies and the segregation of taxable activities from those which are tax-exempt. The ultimate goal in all cases will be to improve the quality of health care while reducing its cost and offering expanded services to the general public.

In its role as parent holding company, it is not anticipated that Q will itself become a provider of health care or other services directed to the public, but rather that it will coordinate the efforts of the autonomous providers and other operating entities which are or become part of the reorganized corporate structure. Instead of focusing on the plans of each individual affiliate, Q will take a broader perspective and be responsible for developing a long- range strategic plan for the overall system. That is, while it is expected that the Board of Directors, officers and management of each affiliate will continue to provide specialized expertise necessary to address the specific activities and unique problems of that particular organization, the talents and energies of Q will focus on broader system-wide issues to ensure that all components work together in a complementary manner to reduce functional overlaps and maximize the utilization of available resources.

In the planning area, Q will review and monitor each affiliate's actual and proposed programs to help ensure that services are or will be delivered efficiently and effectively in order to provide the greatest benefits to the public they serve. For example, it is anticipated that each tax-exempt affiliate within the reorganized system will consent to allow Q to review and make recommendations with respect to the following types of decisions:

1. Development of any new affiliate or taxable subsidiary;

2. Any mortgage, sale, lease, exchange or pledge of assets of any affiliate or subsidiary;

3. Approval of annual operating and capital budgets of the affiliates and subsidiaries;

4. Any non-budgeted acquisition or purchase of real property at a cost exceeding $250,000 within a fiscal year or by contract over a period exceeding one year;

5. Any long-range plan of any affiliate or subsidiary;

6. Any submission of a Certificate of Need application and/or the acceptance of any resulting licensure;

7. The appointment, removal or replacement of the administrative officer responsible for any affiliate or subsidiary; and

8. The approval of any affiliate's Vision, Mission and Annual Leadership Agenda.

Efficiency may dictate the consolidation of certain functions which are currently performed separately by each affiliate. For example, Q expects to create certain system-wide committees comprised of representatives from each tax-exempt affiliate, including system-wide Finance, Audit, and Compensation committees. In addition system-wide task forces will be created to perform strategic planning in areas such as community services and communications, education and research, financial performance and viability, fund development and philanthropy, human resources, marketing and innovation, programs and facilities, and quality and productivity.

Q will also focus upon whether new organizations should be created either to assume certain functions currently performed by existing affiliates or to add new services to the overall system. For example, the adult day-care program currently conducted by U may be transferred to a new not-for-profit, tax-exempt organization so that U becomes a passive subparent within the reorganized corporate system, thereby providing better insulation from intercorporate liabilities. Q may also explore the use of taxable subsidiaries to engage in additional for-profit activities, such as physician practice management services.

In connection with the implementation of the corporate reorganization, it is contemplated that R will gratuitously transfer all of the issued and outstanding stock of a for-profit corporation to Q. As the new sole shareholder, Q will have general oversight powers but will not be involved in the day-to-day management of its operations since the for-profit corporation will have its own staff or purchase necessary management support from R. Any efforts of Q devoted to reviewing or guiding the activities of the for-profit will be strictly incidental to Q's primary function of supporting its tax- exempt affiliates, and, to the extent that Q, R or any other tax- exempt affiliate performs any services for the benefit of the for- profit corporation, it will be charged the full fair market value of such services. You believe that these charges will be insubstantial compared to the financial support Q will receive from its tax-exempt affiliates. Once the stock is transferred to Q, no more than a minority of the directors of the for-profit corporation will be drawn from the directors, officers or employees of any single tax-exempt entity within the corporate system. The for-profit corporation will also maintain separate books and records and otherwise observe separate corporate formalities, including holding its own board meetings. Despite the fact that the for-profit corporation will be independently operated, Q's ownership and control of the stock will ensure that Q is informed of the activities of the for-profit, that its after tax profits will be distributed and used for tax-exempt purposes, and that it will operate in a manner that is consistent with and complements the rest of the reorganized corporate system.

U will continue to maintain similar relationships with its taxable subsidiary. U will not be involved in the day-to-day management of the for-profit's operations since the for-profit has its own staff. No more than a minority of the directors of the for- profit are drawn from the directors, officers or employees of U, Q or any other tax-exempt affiliate. This for-profit also maintains separate books and records and otherwise observes separate corporate facilities, including holding its own Board meetings. U's ownership and control of the for-profit will ensure that U is informed of the for-profit's activities, that its after-tax profits will be distributed and used for tax-exempt purposes, and that it operates in a manner that is consistent with and complements the rest of the reorganized system.

In connection with the implementation of the reorganization, it is possible that funds, assets, personnel and/or services may be transferred by and among the various components of the resulting corporate system. After the parent holding company structure has been put into place by the reorganization, it is possible that funds, assets, services and/or personnel may be shared by and among the participants on an ongoing basis by means of gratuitous transfers (between tax-exempt affiliates), loans, sales or leases. It is anticipated that Q's revenues will be derived primarily from its tax- exempt affiliates, either in the form of contributions or as fees for services it performs on their behalf. In addition, the other exempt affiliates may donate or loan funds to X to enable it to acquire or construct properties which it holds for their benefit. To the extent that Q or any other tax-exempt affiliate provides funds, assets, services and/or personnel to any for-profit entity, those transactions will be structured on an arm's length basis to ensure that each tax-exempt participant is paid full fair market value for its participation. However, any such transactions with Q or any other exempt affiliate will produce revenues which are insubstantial when compared to the selling entity's total receipts and will be strictly incidental to its primary, tax-exempt functions. Q does not expect to undertake any sales of services to its taxable subsidiaries.

As previously noted, W has previously been determined to qualify as a nonprivate foundation under section 509(a)(3) of the Code. However, you believe the financial data you submitted demonstrates that it meets the tests for nonprivate foundation classification under sections 509(a)(1) and 170(b)(1)(A)(vi). You state that reclassification under the latter sections will be advantageous because it will avoid the need to amend W's Certificate of Incorporation to designate additional supported organizations as new tax-exempt affiliates are added to the reorganized corporate system in the future.

You have requested the following rulings in connection with this series of transactions:

1. The reorganization and the resulting corporate structure will not result in the revocation of or otherwise adversely affect the continued tax-exempt status of Q, R, S, T, U, V, and W under section 501(c)(3) of the Code or the continued tax- exempt status of X under section 501(c)(2).

2. The reorganization and the resulting corporate structure will not adversely affect the continued nonprivate foundation status of Q, R, S, T, U, V, and W under section 509(a) of the Code.

3. Any transfer of funds, assets, services and/or personnel in connection with the reorganization and any subsequent sharing of funds, assets, services and/or personnel by and among Q, R, S, T, U, V, W and X will not jeopardize the continued tax- exempt status of the organization providing such funds, assets, services and/or personnel.

4. Any payments for transfers of funds, assets, services and/or personnel in connection with the reorganization and any payments in connection with the subsequent sharing of funds, assets, services and/or personnel by and among Q, R, S, T, U, V, W and X will not generate unrelated business taxable income under sections 511 through 514 of the Code.

5. The incidental furnishing of assets, services, and/or personnel to taxable subsidiary corporations will not adversely affect the continued tax-exempt status of Q, R, S, T, U, V, W or X as long as any transactions are structured on an arm's length basis, the taxable subsidiaries are charged and pay fair market value for all such items, and the resulting revenues constitute no more than an insubstantial part of the total financial support received by the above entities.

You have requested the following additional rulings on behalf of Q:

6. The ownership of 100% of the stock of a taxable subsidiary corporation will not jeopardize the tax-exempt status of Q under section 501(c)(3) of the Code.

7. The taxable income and activities of the taxable subsidiary corporation will not be attributed to Q.

8. Any dividends paid by the taxable subsidiary to Q will be excluded from unrelated business taxable income under section 512(b)(1) of the Code.

You have requested the following additional rulings on behalf of U:

9. The ownership of 100% of the stock of a taxable subsidiary corporation will not jeopardize the tax-exempt status of U under section 501(c)(3) of the Code.

10. The taxable income and activities of the taxable subsidiary corporation will not be attributed to U.

11. Any dividends paid by the taxable subsidiary to U will be excluded from unrelated business taxable income pursuant to section 512(b)(1) of the Code.

You have requested the following additional ruling on behalf of W:

12. W qualifies as a nonprivate foundation described in sections 509(a)(1) and 170(b)(1)(A)(vi) of the Code.

Section 501(a) of the Code provides an exemption from federal income tax for organizations described in section 501(c)(3), including organizations that are organized and operated exclusively for charitable, educational or scientific purposes.

Section 1.501(c)(3)-1(d)(2) of the Income Tax Regulations provides that the term "charitable" is used in section 501(c)(3) of the Code in its generally accepted legal sense.

Revenue Ruling 69-545, 1969-2 C.B. 117, provides that the promotion of health is a charitable purpose within the meaning of section 501(c)(3) of the Code.

Revenue Ruling 67-149, 1967-1 C.B. 133, provides that an organization providing only financial assistance to organizations exempt under section 501(c)(3) of the Code will qualify for exemption under section 501(c)(3).

Revenue Ruling 69-463, 1969-2 C.B. 131, provides that the leasing of its adjacent office building, and the furnishing of certain office services by an exempt hospital to a hospital based medical group is not unrelated trade or business under section 513 of the Code where the medical group performs important health services for the hospital.

Revenue Ruling 78-41, 1978-1 C.B. 148, provides that a trust created by an exempt hospital for the sole purpose of accumulating and holding funds to be used to satisfy malpractice claims against the hospital is operated exclusively for charitable purposes and is exempt under section 501(c)(3) of the Code.

Section 501(c)(3) organizations do not jeopardize their tax exempt status by transferring their assets to other organizations exempt under section 501(c)(3) where the assets transferred are used to further exempt charitable purposes.

Section 1.509(a)-4(f)(1) of the Income Tax Regulations provides that section 509(a)(3)(B) of the Code sets forth three different types of relationships, one of which must be met in order to meet the requirements of that subsection. One of those requirements is "operated, supervised or controlled in connection with." Section 1.509(a)-4(f)(4) of the regulations provides that in the case of supporting organizations which are "supervised or controlled in connection with" one or more publicly supported organizations, the distinguishing feature is the presence of common supervision or control among the governing bodies of all organizations involved, such as the presence of common directors.

Section 511(a) of the Code imposes a tax on the unrelated business income of organizations described in section 501(c).

Section 512(a)(1) of the Code defines unrelated business taxable income as the gross income derived by an organization from any unrelated trade or business regularly carried on by it, less the allowable deductions which are directly connected with the carrying on of the trade or business, with certain modifications.

Section 512(b)(1) of the Code provides, in part, that interest and dividends are excluded from the computation of an exempt organization's unrelated business taxable income.

Section 512(b)(3) of the Code provides that rents from real property (and its incidental related personal property) are not treated as unrelated business income unless the real property is debt-financed under section 514. Debt financed property does not include any property substantially related to the exercise or performance by such organization of its exempt purposes.

Section 512(b)(4) of the Code provides that notwithstanding paragraphs (1), (2), (3), or (5), in the case of debt-financed property (as defined in section 514), there shall be included, as an item of gross income derived from an unrelated trade or business, the amount ascertained under section 514(a)(1), and there shall be allowed, as a deduction, the amount ascertained under section 514(a)(2).

Section 512(b)(5) of the Code provides that all gains and losses from the sale of property other than inventory or property held for sale to customers are excluded from unrelated business taxable income.

Section 512(b)(13) of the Code provides, in part, that notwithstanding paragraphs (1), (2), or (3), amounts of interest, annuities, royalties, and rents derived from any organization (in this paragraph called the "controlled organization") of which the organization deriving such amounts (in this paragraph called the "controlling organization") has control (as defined in section 368(c)) shall be included as an item of gross income (whether or not the activity from which such amounts are derived represents a trade or business or is regularly carried on).

Section 513(a) of the Code defines unrelated trade or business as any trade or business the conduct of which is not substantially related (aside from the need of the organization for funds or the use it makes of the profits derived) to the exercise of the organization's exempt purposes or functions.

Section 514(b) of the Code defines debt-financed property as any property which is held to produce income and with respect to which there is an acquisition indebtedness at any time during the taxable year.

Section 1.513-1(d)(2) of the regulations provides, in part, that a trade or business is related to exempt purposes only where the conduct of the business activities has a causal relationship to the achievement of exempt purposes; and it is substantially related for purposes of section 513 of the Code only if the causal relationship is a substantial one. Thus, for the conduct of trade or business from which a particular amount of gross income is derived to be substantially related to purposes for which exemption is granted, the production or distribution of goods or the performance of the services from which the gross income is derived must contribute importantly to the accomplishment of exempt purposes.

Contributions to organizations exempt from federal income tax under section 501(c)(3) of the Code do not fall within the definition of unrelated business income under section 512, nor create taxable gain or loss to the transferor or transferee.

Q, R, S, T, U, V and W will not adversely affect their tax exempt status under section 501(c)(3) of the Code by the proposed transactions as they will continue to promote health within the meaning of Revenue Ruling 69-545. X will not adversely affect its tax exempt status under section 501(c)(2) by the proposed transactions as its activities will remain unchanged. R will continue to operate as a hospital within the meaning of sections 509(a)(1) and 170(b)(1)(A)(iii) of the Code. Q, S, T, U, V and W will continue to qualify as nonprivate foundations under section 509(a) of the Code.

The transfer or payment for transfers or sharing of funds, assets, services, and/or personnel and liabilities and provision of services by the affiliated non-profit organizations will not result in the recognition of any taxable gain or loss or constitute unrelated business taxable income under sections 511 through 514 of the Code. The tax on unrelated business income is not applicable to these transactions between related exempt organizations because the Code and regulations exclude from the definition of unrelated trade or business any trade or business which contributes importantly to the accomplishment of an organization's exempt purposes. In addition, income received from property, the use of which is substantially related to the furtherance of an exempt purpose constituting the basis for the organization's exemption is not included in unrelated debt financed income under section 514 of the Code.

Neither the Code or regulations prohibit the ownership of taxable subsidiaries by exempt organizations. Since the taxable subsidiaries are separately incorporated and engage in distinct activities and observe separate corporate formalities, and Q, U and the other tax-exempt affiliates are not involved in the day-to-day activities of the taxable subsidiaries, the activities of the taxable subsidiaries will not be attributed directly to Q, U or the other tax-exempt affiliates. Therefore the incidental furnishing of assets, services and/or personnel to the taxable subsidiaries will not adversely affect the exempt status of any of the tax-exempt affiliated organizations. In addition, insubstantial arm's length sales to the taxable subsidiaries which are engaged primarily in health care and related activities do not result in unrelated business taxable income to the exempt affiliated organizations, except for interest, annuities, royalties and rents derived from controlled organizations under section 512(b)(13) of the Code.

The financial information submitted supports reclassification of W's nonprivate foundation classification from section 509(a)(3) of the Code to sections 509(a)(1) and 170(b)(1)(A)(vi).

Accordingly, based on all the facts and circumstances described above, we rule as follows:

1. The reorganization and the resulting corporate structure will not result in the revocation of or otherwise adversely affect the continued tax-exempt status of Q, R, S, T, U, V, and W under section 501(c)(3) of the Code or the continued tax- exempt status of X under section 501(c)(2).

2. The reorganization and the resulting corporate structure will not adversely affect the continued nonprivate foundation status of Q, R, S, T, U, V, and W under section 509(a) of the Code.

3. Any transfer of funds, assets, services and/or personnel in connection with the reorganization and any subsequent sharing of funds, assets, services and/or personnel by and among Q, R, S, T, U, V, W and X will not jeopardize the continued tax- exempt status of the organization providing such funds, assets, services and/or personnel.

4. Any payments for transfers of funds, assets, services and/or personnel in connection with the reorganization and any payments in connection with the subsequent sharing of funds, assets, services and/or personnel by and among Q, R, S, T, U, V, W and X will not generate unrelated business taxable income under sections 511 through 514 of the Code.

5. The incidental furnishing of assets, services, and/or personnel to taxable subsidiary corporations will not adversely affect the continued tax-exempt status of Q, R, S, T, U, V, W or X as long as any transactions are structured on an arm's length basis, the taxable subsidiaries are charged and pay fair market value for all such items, and the resulting revenues constitute no more than an insubstantial part of the total financial support received by the above entities.

6. The ownership of 100% of the stock of a taxable subsidiary corporation will not jeopardize the tax-exempt status of Q under section 501(c)(3) of the Code.

7. The taxable income and activities of the taxable subsidiary corporation will not be attributed to Q.

8. Any dividends paid by the taxable subsidiary to Q will be excluded from unrelated business taxable income under section 512(b)(1) of the Code.

9. The ownership of 100% of the stock of a taxable subsidiary corporation will not jeopardize the tax-exempt status of U under section 501(c)(3) of the Code.

10. The taxable income and activities of the taxable subsidiary corporation will not be attributed to U.

11. Any dividends paid by the taxable subsidiary to U will be excluded from unrelated business taxable income pursuant to section 512(b)(1) of the Code.

12. W qualifies as a nonprivate foundation described in sections 509(a)(1) and 170(b)(1)(A)(vi) of the Code.

These rulings are based on the understanding that there will be no material changes in the facts upon which they are based.

These rulings are directed only to the organization that requested them. Section 6110(j)(3) of the Code provides that they may not be used or cited by others as precedent.

These rulings do not address the applicability of any section of the Code or regulations to the facts submitted other than with respect to the sections described.

We are informing your key District Director of this action. Please keep a copy of these rulings in your permanent records.

                                   Sincerely,