REDLANDS SURGICAL SERVICES v. Commissioner

113 T.C. No. 3

• Court: United States Tax Court
• Decided: July 19, 1999
• Docket: 11025-97X
• Status: Unknown

Opinion

113 T.C. No. 3

UNITED STATES TAX COURT

REDLANDS SURGICAL SERVICES, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 11025-97X. Filed July 19, 1999.

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. - 2 -

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 case fully

stipulated under Rule 122 on the basis of the pleadings and the

stipulated administrative record, which is incorporated herein by

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

1 Unless otherwise indicated, all section references are to the Internal Revenue Code as in effect for the time period referred to. All Rule references are to the Tax Court Rules of Practice and Procedure. - 3 -

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.

Redlands Hospital

Since its founding in 1929, Redlands Hospital has been

recognized by respondent as a charitable organization described - 4 -

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. - 5 -

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

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.

2 Redlands Hospital is also a signatory to the general partnership agreement but only with respect to secs. 16 and 17 of that agreement (regarding noncompetition and affiliated status). 3 As of 1995, SCA owned, in whole or part, and operated approximately 40 ambulatory surgery centers throughout the United States, some of which were owned in part by tax-exempt health care systems. - 6 -

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

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 - 7 -

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. - 8 -

(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 following arbitration procedure to resolve the matter. Within three (3) days of a Partner's notifying the other of institution of this arbitration procedure, each Partner shall select an arbitrator to resolve the matter. Within seven (7) days after the selection of the arbitrators, those arbitrators shall select a third. Within five (5) days after selection of the third arbitrator, each Partner shall submit in writing to each of the arbitrators the Partner's position on the matter to be resolved. The arbitrators shall decide the matter and advise the Partners in writing of their decision within fourteen (14) days after the Partners' submission of their written positions. In hearing such arbitration the arbitrators shall determine the procedural rules to be applied and shall apply the substantive law of the State of California without regard to conflict of law considerations. The decision of a majority of the arbitrators shall be final and binding. The costs and expenses of the arbitrators shall be divided equally between the Partners.

(b) Medical Advisory Group. The determination of all questions relating to the medical standards and medical policies of the center shall rest with the Medical Advisory Group. The determination as to what constitutes a medical decision, standard or policy shall rest with the Managing Directors. The Managing Directors shall select 50 percent of the Medical Advisory Group. - 9 -

(c) Operating Partnership Agreement and Purchase Agreement. RHS hereby authorizes SCA Centers to execute on behalf of the Partnership: (i) the Operating Partnership's Partnership Agreement; (ii) an agreement to acquire the General Partner Interest (the "Purchase Agreement"); and (iii) all exhibits to the Purchase Agreement.

12. Management Agreement. The Operating Partnership shall enter into a Management Agreement with SCA Management Company, a wholly-owned subsidiary of SCA ("Management") whereby Management assumes full responsibility for administering the day-to- day operation of the ambulatory center in accordance with the goals, policies and objectives of the Operating Partnership. The Agreement will be for a term of fifteen (15) years with two (2) five (5) year extensions at Management's sole discretion and will provide Management with a fee equal to Six Percent (6%) of the Operating Partnership's gross revenues. Legal, accounting, travel, lodging, meals and other such professional services associated with the management and administration of the ambulatory surgery center shall be reimbursed to Management.

13. Quality Assurance Agreement. Management shall enter into an [sic] Quality Assurance Agreement with RHS whereby RHS will agree to perform certain managerial and supervisory quality assurance duties in connection with the operation of the Center. The Quality Assurance Agreement will continue from year to year unless terminated by either of the parties thereto. RHS will receive no fee under the Quality Assurance Agreement during the first year thereof and thereafter will be paid a fee equal to one percent of gross revenues as defined in such Agreement, payable monthly.

* * * * * * * - 10 -

16. Non-Compete. The Partners and RHS hereby agree that during the term of this Partnership, and for two years thereafter, neither party, nor an affiliate of either party, shall participate in the ownership, management or development of a free-standing surgical center which is within those portions of San Bernardino and Riverside Counties falling within a twenty (20) miles radius of the Center unless authorization is obtained from the other party. Further, the Hospital shall not expand or promote its present outpatient surgery program within the Hospital. Notwithstanding the foregoing in the event that either Partner acquires the entire interest of the other Partner herein, this Section 16 shall not apply thereafter to the purchasing Partner or its affiliates.

17. Affiliated Status. To the extent legally permissible, the Hospital agrees to recognize the surgery center as an affiliate for managed care contracting purposes (i.e., HMOs and PPOs).

18. New Services and Procedures.

(a) Exhibit B lists medical services and procedures currently available at the Center and those which the Partners expect to be performed there in the near future. SCA Centers acknowledges that (1) RHS is an affiliate of the Hospital, and (2) that the Hospital enjoys a valuable reputation in the area for providing quality medical care to patients, (3) that the Hospital's association with the Center through RHS's participation in this Partnership will benefit the Center and (4) that RHS has an important interest in ensuring that services and procedures performed at the Center, or by an entity with which RHS is associated by virtue of this Partnership, within the Hospital's service area are only such services and procedures which are recognized by a majority of the medical community as - 11 -

being safely and efficaciously performed in a non-hospital, outpatient setting.

(b) Unless otherwise approved by the Managing Directors (whose actions in matters under this Paragraph shall be final and not subject to arbitration or review, even if deadlocked), no procedures or services currently available to patients in the State of California which are not listed on Exhibit B shall be performed at the Center (or by RHS, SCA or the Center limited partnership, or an affiliate of any of them, excluding the Hospital), within the area set forth in Paragraph 16, unless and until such procedures or services are performed or available on a non-hospital, outpatient basis at a majority of the free-standing outpatient surgery facilities in Imperial, Kern, Los Angeles, Orange, Riverside, San Bernardino, San Diego and Ventura Counties.

(c) With respect to new services or procedures which first become available in California during the term hereof, such services or procedures shall not be performed by RHS, SCA, the Center limited partnership or an affiliate of any of them in the area identified above until the Managing Directors determine, based on reliable medical evidence and/or testimony, that such services and procedures can be safely and efficaciously performed on a non- hospital, outpatient basis.

23. Assignment. Each Partner shall have the right, without the prior approval of the other and without triggering the provisions of paragraph 14 hereof, to transfer or assign all or any part of its interest in this Partnership to an affiliated entity; * * * in the event either Partner assigns its - 12 -

interest hereunder the provisions of Section 16, shall continue to apply to the assignor, as well as to the assignee, and the interest held by the assignee shall be subject to repurchase as provided in Section 19 hereof, upon the breach of Section 16 by the assignor, the assignee [or] their Affiliates.

The General Partnership’s Acquisition of the Operating Partnership Interest

Effective April 30, 1990, the General Partnership entered

into an amended and restated agreement of the Operating

Partnership in accordance with the Revised Limited Partnership

Act of the State of California. Pursuant to this agreement, the

General Partnership acquired, for approximately $3 million, a 61-

percent general partnership interest in the Operating

Partnership.4 As part of the purchase price, the General

Partnership agreed to contribute $1,598,495 by delivering to the

limited partners (with the exception of Beaver Medical Clinic)

shares of SCA common stock with an equivalent market value.5

4 Prior to Apr. 30, 1990, the three general partners of the Operating Partnership were two individuals who had aggregate ownership interests of 24 percent, and Beaver Medical Clinic, Inc., which had a 6-percent ownership interest. Effective Apr. 30, 1990, the two individual general partners sold their aggregate 24-percent interests, and Beaver Medical Clinic, Inc. converted its 6-percent general partner interest into a 10.3- percent limited partner interest. The other limited partners are physicians who are also on the medical staff of Redlands Hospital. 5 The General Partnership subsequently reduced its ownership interest in the Operating Partnership to 59 percent as a result of the sale of 2 percent of the general partner interest to a (continued...) - 13 -

To determine the General Partnership’s investment, the

Operating Partnership was valued at four to five times earnings.

No formal appraisal was acquired; rather, the valuation was

determined based on SCA’s experience and knowledge of the market

and by a review of historical records. An unrelated bidder (a

for-profit company, not otherwise identified in the record) was

offering the Operating Partnership a higher purchase price based

on approximately six times earnings. The existing partners of

the Operating Partnership agreed to the offer made by the General

Partnership due to the desire to have an affiliation with

Redlands Hospital for quality control review and other reasons,

such as to supervise the teaching and maintenance of up-to-date

surgery methodologies.

The General Partnership is the sole general partner of the

Operating Partnership. There are 32 limited partners. Except

for Beaver Medical Clinic, Inc., the limited partners are all

physicians who are also on the medical staff of Redlands

Hospital. Two of the limited partners are board members of

Redlands Hospital and RHS. The amended Operating Partnership

agreement contains no statement of charitable purpose and imposes

no requirement that the Operating Partnership operate for a

5 (...continued) physician, with that interest then being converted to a limited partner interest. The limited partners currently have a 41- percent interest in the Operating Partnership. - 14 -

charitable purpose. Relevant portions of the amended Operating

Partnership agreement are set out below:

AMENDED AND RESTATED CERTIFICATE AND AGREEMENT OF LIMITED PARTNERSHIP OF INLAND SURGERY CENTER, L.P.

IV. BUSINESS

The business of the Partnership is to own and operate the Center and to carry on any and all activities necessary, proper, convenient, or advisable in connection therewith.

VI. CAPITAL CONTRIBUTION, STATUS AND ADDITIONAL WORKING CAPITAL

6.1 Capital Contribution of the General Partner. Upon execution of this Agreement, the General Partner will contribute $1,979,077 to the Partnership to be paid $1,655,842 by check or by wire transfer and $1,598,495 by delivering Shares,[6] which shall be simultaneously distributed to the Limited Partners, other than [Beaver Medical Clinic], in the amounts set forth on Schedule C. For purposes of payment of the contribution, the Shares shall be valued at the average of the closing prices of the Shares, as reported by the NASDAQ National Market System, on each of the five trading days which are prior to the ten business days prior to April 30, 1990.

SCA will also make available to each Limited Partner, other than [Beaver Medical Clinic], appropriate officers of SCA who will respond to questions relating to the material furnished and the business and affairs of SCA.

The Limited Partners who receive such shares shall not sell, exchange, pledge hypothecate or otherwise dispose

6 Paragraph 1.25 of the Operating Partnership agreement defines “Shares” as “$.01 par value common stock of SCA”. - 15 -

of the shares prior to the date six months have elapsed from the date this Agreement is executed. In any transfer of the Shares, the Limited Partners shall comply with the prospectus delivery requirements of the Securities Act of 1933.

7.3 Management Fees. SCA Management Company, a subsidiary of SCA, will enter into a Management Agreement with the Partnership pursuant to which SCA Management Company will provide management, purchasing and other services and support to the Partnership. SCA Management Company will be reimbursed for any direct costs incurred in managing the Partnership and will be paid an annual management fee equal to 6% of the Partnership’s Gross Revenues payable monthly.

VIII. ALLOCATION OF INCOME AND LOSS: CASH DISTRIBUTIONS

8.1 Available Cash Flow. The Partnership shall distribute Available Cash Flow and any other property received by the Partnership as a result of the operations of the Center or sale of its assets (a) 1.1366% to the holder of each outstanding Unit,(b) 10.3% to [Beaver Medical Clinic] and (c) the balance to the General Partner.

8.4 Profits and Losses. Profits and losses shall be allocated 10.3% to [Beaver Medical Clinic], 1.1366% to the holder of each Unit and the balance to the General Partner. * * *

IX. RIGHTS, POWERS AND OBLIGATIONS OF THE GENERAL PARTNER

9.1 Powers. The management and control of the Partnership and its business and affairs shall rest exclusively with the General Partner, which shall have all the rights and powers which may be possessed by a general partner pursuant to the Act, and such additional rights and powers as are otherwise conferred by law or are necessary, advisable or convenient to the discharge of its duties under this Agreement. The General Partner shall be the “tax matters partner” within the meaning of the Code. Without - 16 -

limiting the generality of the foregoing, the General Partner may, at the cost, expense and risk of the Partnership:

9.1.1. Spend the capital and net income of the Partnership in the exercise of any rights or powers possessed by the General Partner hereunder;

9.1.2. Lease the Land, manage and operate the Center and enter into agreements containing such terms, provisions and conditions as the General Partner in its discretion shall approve;

9.1.3. Purchase from or through others contracts of liability, casualty and other insurance which the General Partner deems advisable for the protection of the Partnership or for any purpose convenient or beneficial to the Partnership;

9.1.4. Incur indebtedness in the ordinary course of business;

9.1.5. Subject to the provisions of Section 9.4.1.2 of this Agreement, sell or otherwise dispose of, upon such terms and conditions as the General Partner may deem advisable, appropriate or convenient, any of the assets of the Partnership;

9.1.6. Invest in short-term debt obligations (including obligations of federal and state governments and their agencies, commercial paper and certificates of deposit of commercial banks, savings banks or savings and loan associations) and “money market” mutual funds, such funds as are temporarily not required for the purposes of the Partnership’s operations; and

9.1.7. Delegate all or any of its duties hereunder and, in furtherance of any such delegation, appoint, employ, or contract with any person (including affiliates of the General Partner) for the transaction of the business of the Partnership, which persons may, under the supervision of the General Partner, act as consultants, accountants, attorneys, brokers, escrow agents, or in any other capacity deemed by the General Partner necessary or desirable, and - 17 -

pay appropriate fees to any of such persons; provided, however, the General Partner shall not delegate duties hereunder which are required to be performed by SCA Management Company under the Management Agreement.

9.2. Independent Activities. Subject to the provisions of Section 16.2 of this Agreement, the General Partner and each Limited Partner may, notwithstanding the existence of this Agreement, engage in whatever activities they choose, whether or not the same be competitive with the Partnership, without having or incurring any obligation to offer any interest in such activities to the Partnership or any party hereto, and, as a material part of the consideration for the General Partner’s execution hereof and for the admission of such Limited Partner, each Limited Partner hereby waives, relinquishes and renounces any such right or claim of participation.

9.3. Duties. The General Partner shall manage and control the Partnership, its business and affairs to the best of its ability and shall use its best efforts to carry out the business of the Partnership. The General Partner shall devote itself to the business of the Partnership to the extent that it, in its discretion, deems necessary for the efficient carrying on thereof. The General Partner shall act as a fiduciary with respect to the safekeeping and use of the funds and assets of the Partnership.

9.4. Certain Limitations.

9.4.1 Without obtaining the consent of all of the Partners, the General Partner shall not:

9.4.1.1. Act in contravention of this Agreement;

9.4.1.2. Except as provided in Article XII of this Agreement, do any act which would make it impossible to carry on the ordinary business of the Partnership;

9.4.1.3. Confess a judgment against the Partnership;

9.4.1.4. Assign the Partnership property in trust for creditors or on the assignee’s promise to pay the debts of the Partnership; - 18 -

9.4.1.5. Submit a Partnership claim or liability to arbitration or reference; or

9.4.1.6. Dispose of the goodwill of the Partnership.

9.6. Medical Advisory Group. The Partnership shall have a Medical Advisory Group consisting of six Limited Partners appointed annually. Three members of the Medical Advisory Group shall be appointed by [Beaver Medical Clinic]. The three remaining members shall be appointed by the General Partner. Vacancies in the Medical Advisory Group shall be filled in accordance with the above procedure. Subject to law regulations, and the standards of applicable regulatory bodies, the medical standards of the Partnership will be under the control of the Medical Advisory Group. The General Partner will determine what are medical standards and policies.

10.4 Government Regulation. In the event that, in the opinion of counsel to the Partnership, the referral of Medicare or any other patients to the Center by Partners becomes illegal, the Partnership shall require each Limited Partner to offer his interest to the General Partner for five times the reportable taxable income allocated to that interest on the Partnership Return for the tax year immediately preceding the year in which counsel determines such reference is illegal. Up to 50% of the purchase price shall, at the option of the General Partner, be paid in unregistered Shares. The General Partner shall have 30 days in which to accept such offer.

XV. LIABILITY OF THE GENERAL PARTNER

15.1. Return of Capital Contribution. Anything in this Agreement to the contrary notwithstanding, the General Partner shall not be individually liable for the return of the Capital Contributions of the Limited Partners, or any portion thereof, it being expressly understood that any such return shall be made solely from Partnership assets. - 19 -

15.2. Exculpation and Indemnification. The doing of any act or the failure to do any act by the General Partner shall not subject the General Partner to any liability to the Partnership or the Partners, except for gross negligence or willful malfeasance. The Partnership shall indemnify the General Partner against losses sustained in connection with the Partnership, provided that the losses were not the result of gross negligence, self-dealing or willful malfeasance on the part of the General Partner.

16.5. Amendments. Amendments to this Agreement may be proposed by the General Partner or Limited Partners with a Limited Partnership Percentage in excess of 50%.

16.5.2. In addition to any amendments otherwise authorized herein, the General Partner may, without obtaining the consent of the Limited Partners, amend this Agreement from time to time:

(a) To add to the representations, duties or obligations of the General Partner or its affiliates or surrender any right or power granted to the General Partner or its affiliates herein, for the benefit of the Limited Partners; and

(b) To cure any ambiguity, to correct or supplement any provision herein * * * which may be inconsistent with any other provision herein, or to make any other provisions with respect to matters or questions arising under this Agreement * * * as the case may be, which will not be inconsistent with the provisions of this Agreement * * *, provided that the Partnership receives a written opinion of independent counsel that such amendment does not adversely [a]ffect the interests of the Limited Partners.

(e) Upon advice of counsel that the operations of the Partnership are in violation of law, to cause this Agreement to comply with law; provided, however, such amendments shall not alter materially the economic objectives of the - 20 -

Partnership and, further, provided that any amendment to or deletion of any provision shall not in the opinion of the General Partners materially reduce the economic return to the Limited Partners.

The Management Contract With SCA Management

Pursuant to the provisions of paragraph 12 of the General

Partnership agreement, supra, and paragraph 7.3 of the Operating

Partnership agreement, supra, on April 30, 1990, the Operating

Partnership entered into a contract with SCA Management, whereby

SCA Management was retained “for the purpose of rendering

management, administration and purchasing services and support,

and all other management support needed for operation and, in the

best interest, of the [Surgery] Center”. The management

agreement is signed on behalf of both the Operating Partnership

and SCA Management by David E. Crockett, in his capacities as

secretary and vice president, respectively, of these two

entities.

Pursuant to the management contract, SCA Management has

wide-ranging authority for operational management of the Surgery

Center, except that it has “no power or authority to make any

decision relating to the care or treatment of patients or other

medical matters”, this power and authority being specifically

reserved to the Operating Partnership’s Medical Advisory - 21 -

Committee.7 SCA Management is authorized to enter into contracts

relating to the affairs of the Surgery Center, subject to certain

exceptions, requiring express authorization of the Operating

Partnership. These exceptions include lease or contractual

obligations requiring payments in excess of $50,000 in any 12-

month period, and obligations to a related party in excess of

$5,000.

The management contract states that SCA Management is

authorized to provide services to the Operating Partnership

(referred to as “the Owner” in the following quoted provisions),

as follows:

II. MANAGEMENT SERVICES

1. Subject to the provisions of Article I, the Manager will render all services, direction, advice, supervision and assistance in the operation of the Center, as necessary, including, but not in any way limited to, the following:

A. Maintaining the accreditation of the Center with the proper agencies and insurance companies;

B. Arranging for the purchase by the Owner of hazard, liability, professional and other necessary insurance coverage for the Center; provided, however, that the physicians practicing in the Center shall obtain their own malpractice insurance;

C. Employing, supervising, directing, leasing and discharging on behalf of the Owner, all non-physician personnel performing services at the Center, including

7 Under paragraph 9.6 of the Operating Partnership agreement, the general partner (i.e., the General Partnership) determines what are medical standards and policies. - 22 -

the administrator of the Center, as needed. The administrator shall be subject to the Owner's approval.

D. Negotiating fee payment methods, including Medicare reimbursement, with the appropriate third party payers and state and federal agencies;

E. Establishing staffing schedules, wage structures and personnel policies for all personnel;

F. Determining and setting patient charges for services provided by the Center, excluding charges for physicians' services, and arranging for payment of such charges by others, when appropriate;

G. Providing administrative policies and non- medical operating procedures to all departments;

H. Providing standard formats for all charts, invoices and other forms used in the operation of the Center;

I. Providing for the purchase or lease by the Owner of all supplies and equipment used in the operation of the Center;

J. Directing the day-to-day operations of the Center to insure the operations are conducted in a business-like manner;

K. Developing an ongoing advertising and promotion program;

L. Negotiating or retaining on behalf of the Owner contractual relationships for anesthesiology, radiology and pathology services, as appropriate; and

M. Performing all management and non-medical oversight responsibilities for the Owner.

2. All costs and expenses incurred with respect to the services specified in Paragraph 1 above will be borne by the Manager.

III. ACCOUNTING AND BOOKKEEPING SERVICES

1. The Manager agrees to review, direct and supervise the following accounting and bookkeeping services for the Owner in the operation of the Center. - 23 -

A. Receipt for and deposit in a special bank account selected by the Owner, separate from all other monies of the Manager, all funds received from the operation of the Center and supervise the disbursement of such funds for the operating expenses of the Center;

B. Maintain the books of account, including all journals and ledgers, check register and payroll records;

C. Post all patient and other charges, including necessary analysis and corrections;

D. Establish adequate receivable, credit and collection policies and procedures;

E. Process vendor's invoices and other accounts payable;

F. Prepare payroll checks from time sheet summaries prepared under the Manager's supervision;

G. Prepare payroll and supervise preparation of the Owner's tax returns (fees paid to independent accountants will be the responsibility of the Owner);

H. Prepare monthly bank reconciliations;

I. Prepare and distribute to the Owner monthly profit and loss statements;

J. Establish patient insurance billing procedures;

K. Furnish the Owner on or before the 30th day following the end of each calendar quarter (i) an accrual basis balance sheet of the Owner at the end of the previous quarter and (ii) an accrual basis statement of income for the quarter then ended of "available cash" at the end of such quarter and (iii) a list of all outstanding and unpaid obligations of the Owner at the end of such quarter. * * *

L. Furnish the Owner for its approval, during the fourth quarter of each fiscal year, the operating budget and capital expenditure budget of the Center for the next fiscal year. - 24 -

Under the management contract, SCA Management is entitled to

receive a monthly management fee equal to 6 percent of gross

revenues, defined as the net collectable portion of revenues

billed as fees or other charges arising out of the operation of

the Surgery Center, with no deduction for bad debts. In

addition, SCA Management is entitled to be reimbursed for direct

expenses incurred in managing the Surgery Center. The Operating

Partnership is required to approve any single expense in excess

of $5,000.

The term of the management contract is equal “to the term of

any indebtedness, lease or other obligation of the * * *

[Operating Partnership] guaranteed by SCA or an affiliate of SCA

but not less than 15 years.” The management agreement is

renewable by SCA Management at its option for two 5-year terms.

Except for circumstances involving bankruptcy or insolvency, the

management contract is terminable by the Operating Partnership

only if SCA Management breaches the agreement, and then generally

only after a 90-day notice and 90-day cure period.

Managing Directors of the General Partnership

As indicated in paragraph 4 of the General Partnership

agreement, supra, overall management of the General Partnership,

except for questions of medical standards and medical policies,

is vested in its managing directors, consisting of four persons,

two of whom are appointed by petitioner, and two of whom are - 25 -

appointed by SCA Centers. The managing directors of the General

Partnership meet on a quarterly basis. Their activities and

responsibilities include:

a. Developing and approving the Surgery Center's

capital and operating budgets;

b. Approving distributions of the Surgery Center's

earnings;

c. Hiring and firing the Surgery Center's manager;

d. Reviewing the Surgery Center's financial results;

e. Reviewing proposed capital equipment purchases of

the Surgery Center;

f. Appointing one-half of the members of the Surgery

Center Medical Advisory Committee;

g. Facilitating the lending of equipment from

Redlands Hospital to the Surgery Center;

h. Reviewing the Surgery Center's use of nursing

staff;

i. Coordinating training and mentoring opportunities

between Redlands Hospital and the Surgery Center;

j. Approving any long-term debt obligations;

k. Approving any obligations for repairs, equipment,

additions, or betterments to the Surgery Center;

l. Approving any lease or contractual obligations

requiring payments in excess of $50,000 in the aggregate for - 26 -

any twelve-month period or those obligations not in the

ordinary course of business; and

m. Approving any obligation to a related party in

excess of $5,000.

Quality Assurance Agreement

Paragraph 13 of the General Partnership agreement, supra,

requires SCA Management to enter into a quality assurance

agreement with RHS whereby RHS will agree to perform “certain

managerial and supervisory quality assurance duties” in

connection with the operation of the Surgery Center. The General

Partnership agreement provides that the quality assurance

agreement is to continue from year to year unless terminated by

either of the parties.

Effective April 30, 1990, SCA Management and RHS entered

into a quality assurance agreement. The agreement states that

SCA Management “retains RHS for the purpose of the management and

supervision of quality assurance programs for the [Surgery]

Center and [to] oversee its affairs, and for providing additional

services as SCA [Management] may reasonably request.”

The quality assurance agreement recites as one of its

premises that SCA Management “desires to reimburse RHS for

certain services, including without limitation management and the

supervision of quality assurance programs with respect to the

[Surgery] Center.” Under the quality assurance agreement, RHS - 27 -

was to receive no fee during the first year and thereafter was to

be paid a monthly fee equal to 1 percent of gross revenues. In

addition, SCA Management was to reimburse RHS for its direct out-

of-pocket expenses incurred in managing and supervising the

quality assurance program. The quality assurance agreement

states that RHS' appointees as managing directors shall not

receive any compensation from SCA Management, but that SCA

Management shall reimburse them for all reasonable travel

expenses and out-of-pocket expenses.

On September 30, 1990, RHS transferred its obligations and

rights under the Quality Assurance Agreement to petitioner.

By its terms, the quality assurance agreement was to

continue from year to year unless terminated by either SCA

Management or petitioner. The quality assurance agreement was to

terminate automatically, however, if the number of surgical cases

performed at the Surgery Center was less than 4,225 during any

year. The agreement states that if it is terminated for any

reason, the parties agree to negotiate in good faith an agreement

on substantially the same terms.

Medical Advisory Group

Pursuant to paragraph 9.6 of the Operating Partnership

agreement, supra, all questions regarding medical standards and

policies at the Surgery Center are determined by a Medical

Advisory Group, which also reviews procedures being performed at - 28 -

the Surgery Center. The Medical Advisory Group is composed of

six physicians who are all limited partners of the Operating

Partnership. The managing directors of the General Partnership

select three members of the medical advisory group; Beaver

Medical Clinic--which is a limited partner in the Operating

Partnership--selects the other three members. Prior to the

affiliation of the General Partnership with the Surgery Center,

the Medical Advisory Group was inactive.

Redlands Surgical Services (Petitioner)

On August 1, 1990, 5 months after entering into the General

Partnership agreement, RHS incorporated petitioner as a

California nonprofit public benefit corporation. On September

30, 1990, RHS transferred its interest in the General Partnership

to petitioner.

RHS formed petitioner with the intent that petitioner's sole

planned activity would be its efforts with respect to the

Operating Partnership. The decisions to incorporate petitioner

as a separate corporate entity and to transfer the interests in

the General Partnership to petitioner were made to protect

Redlands Hospital and Redlands Foundation from potential

creditors of the Surgery Center and to keep petitioner's and the

Surgery Center's activities free of the debt covenants of

Redlands Hospital. - 29 -

Petitioner’s articles of incorporation state in relevant

part:

ONE: The name of this Corporation is REDLANDS SURGICAL SERVICES.

TWO: This Corporation is a nonprofit public benefit corporation and is not organized for the private gain of any person. It is organized under the Nonprofit Public Benefit Corporation Law for charitable purposes. The corporation is organized solely for the benefit of, and to carry out the charitable purposes as stated in the respective Articles of Incorporation of (a) RHS Corp., a California nonprofit corporation, (b) Redlands Community Hospital, a California nonprofit Corporation, and (c) Redlands Community Hospital Foundation, a California nonprofit corporation.

FOUR: (a) The property of this corporation is irrevocably dedicated to charitable purposes, and no part of the net income or assets of this corporation shall ever inure to the benefit of any director, officer or member of this corporation, or to the benefit of any private individual.

FIVE: (a) This corporation is organized exclusively for charitable purposes within the meaning of Section 501(c)(3) of the Internal Revenue Code. Notwithstanding any other provisions of these Articles, the corporation shall not carry on any activities not permitted to be carried on (i) by a corporation exempt from Federal income tax under Section 501(c)(3) of the Internal Revenue Code of 1954, as amended (or the corresponding provision of any future United States Internal Revenue Law or (ii) by a corporation, contributions to which are deductible under Section 170(c)(2) of the Internal Revenue Code of 1954, as amended (or the corresponding provision of any future United States Internal Revenue Law). - 30 -

Petitioner's bylaws limit membership to one member. The

sole member is RHS, which has the right to elect, remove, and

fill vacancies in petitioner's Board of Directors. Petitioner's

bylaws provide that the directors must be among those persons

serving as members of the Enterprise Committee of petitioner's

parent corporation RHS.

Petitioner's sole source of financial support is its share

of the revenues from the Operating Partnership. Petitioner has

no paid or salaried employees. The president of Redlands

Hospital serves concurrently as petitioner’s president.

The Surgery Center's Operations

The Surgery Center operates on a nondiscriminatory basis

both as to doctors and patients. There are no restrictions as to

whether a surgical patient can be operated on at the Surgery

Center, other than a review as to the appropriateness of

conducting the surgical procedure in an outpatient setting and

the overall medical condition of the patient. There is

practically a 100-percent overlap between surgeons who operate at

Redlands Hospital and at the Surgery Center.

Between 1990 and 1995, the number of surgical procedures

performed at the Surgery Center increased 10 percent. Over the

same period, the number of outpatient surgeries performed at

Redlands Hospital decreased from 2,239 to 1,864.8

8 The administrative record does not reflect the number of (continued...) - 31 -

Procedures Authorized To Be Performed at the Surgery Center

The General Partnership agreement specifies the types of

medical services and procedures to be available at the Surgery

Center, which include: Arthroscopic surgeries, laproscopic

surgeries (including hysterectomies and appendectomies),

conizations, tonsillectomies, herniorrhaphy and eye surgeries.

When such procedures involve a higher-risk patient, they are

performed at Redlands Hospital or another acute-care hospital.

The decision to perform surgery at a hospital rather than at the

Surgery Center is exclusively a medical decision.

The General Partnership agreement generally provides that,

unless otherwise approved by the managing directors, the Surgery

Center will not perform new surgical procedures until they are

available on a nonhospital, outpatient basis at a majority of

freestanding outpatient surgery facilities in the area. If the

managing directors deadlock over approval of new procedures, the

arbitration provisions of the partnership agreement do not apply

to break the deadlock.

Petitioner's appointees to the managing directors have

successfully blocked various proposals by SCA Centers that

additional surgical procedures be conducted at the Surgery

Center. For example:

8 (...continued) outpatient surgical procedures performed at the Surgery Center or Redlands Hospital since 1995. - 32 -

-- SCA Centers requested that Redlands Hospital transfer all

of its outpatient surgery volume to the Surgery Center.

Petitioner's appointees to the managing directors, however,

did not feel that this was an appropriate use of the

facility nor in the best interests of Redlands Hospital and

voted against this proposal. As a result, outpatient

surgeries continue to be performed at Redlands Hospital.

-- SCA Centers proposed that the Surgery Center offer new

surgical procedures that would require the patient to stay

overnight to recover. Petitioner's representatives did not

think this was an appropriate service to offer at the

Surgery Center and voted against performing these procedures

at the Surgery Center. As a result, surgical procedures

that require 24-hour recovery time are performed at a

hospital.

-- SCA Centers proposed that physicians be permitted to

perform retinal attachments at the Surgery Center and

requested that the Surgery Center purchase the necessary

equipment for the surgical procedure. Petitioner did not

believe there was sufficient volume in the Redlands patient

community to maintain quality control over this type of

surgery, and so its two appointees to the managing directors

voted against the purchase of the equipment and the - 33 -

performance of this type of eye surgery at the Surgery

Center.

In addition, petitioner’s appointees to the board of

directors voted against SCA Center’s proposal to bill on behalf

of Redlands Hospital for outpatient surgeries performed there.

Payment for Services

The Surgery Center's charges are determined on the basis of

customary and usual charges for similar services provided by

other organizations in the area. The Surgery Center offers no

free care to indigents and has no emergency room or certification

to treat the emergency patient population. For persons who are

unable to pay, an effort is made to provide all necessary

services and to assist the patient in qualifying for appropriate

medical coverage including Medi-Cal. The Surgery Center also

provides payment plans for patients to make payment for

procedures more affordable.

Since the General Partnership acquired its interest in the

Operating Partnership, the Surgery Center has accepted more

managed care (i.e., care provided by health maintenance

organizations (HMO's)). Prior to April 1990, the Surgery Center

had HMO contracts with 7 HMO's and preferred provider

organizations (PPO's). As of April 1994, the Surgery Center had

contracts with 21 HMO's and PPO's. For the last 6 months of

1993, managed care (i.e., care provided by HMO's and PPO's) - 34 -

accounted for almost half of the Surgery Center's total facility

invoices. The General Partnership agreement states that Redlands

Hospital agrees to recognize the Surgery Center as an affiliate

for managed care services to the extent legally permissible.

For the last 6 months of 1993, Medicare accounted for about

12 percent of total Surgery Center invoices. Because greater

medical risks attend surgery of older patients, such as the

typical Medicare patient, most Medicare surgeries are performed

in a hospital setting, rather than in a surgery center.

Medicaid reimbursements are substantially below those

provided by Medicare. Medi-Cal is the State of California's

Medicaid program under Federal law. The California Medi-Cal

patient group consists, in large part, of indigents, mothers, and

children. These patients' greatest needs are for emergency room

and obstetrics and gynecology (OB/GYN) medical service. As a

result, this group of patients is more likely to avail themselves

of the emergency room facilities at Redlands Hospital rather than

either Redlands Hospital's or the Surgery Center's surgical

facilities.

The Surgery Center has no contract with Medi-Cal directly,

although a negligible amount of Medi-Cal coverage is provided for

surgeries performed at the Surgery Center pursuant to

participating hospital agreements between Redlands Hospital and

the Blue Cross of California Medi-Cal Managed Care Program,

effective December 1, 1994, and between Redlands Hospital and - 35 -

PacifiCare of California, a California HMO, effective June 1,

1994. For the last 6 months of 1993, the Surgery Center's

Medicaid invoices totaled 18, or less than 1 percent (8/10 of 1

percent) of all its invoices.

Integration of the Activities of Redlands Hospital and the Surgery Center

Since its affiliation with the General Partnership, the

Surgery Center has served as a training site for Redlands

Hospital nurses in outpatient procedures. Redlands Hospital

nursing surgery staff members train at the Surgery Center in

circumstances where the frequency of a particular surgery at the

Surgery Center makes such training more efficient and economical.

This is especially true of procedures that are more often

performed at the Surgery Center than at Redlands Hospital (e.g.,

tonsillectomy and cataract surgeries).

To be a member of the Redlands Hospital physician staff, a

physician must be board-certified in his or her specialty and

regarded by Redlands Hospital as a capable practitioner.

Redlands Hospital uses a "proctory" review process to approve new

members of its physician staff. Before the General Partnership

acquired its interest in the Surgery Center, no proctoring was

conducted at the Surgery Center. Since the affiliation of the

Surgery Center with the General Partnership, it is frequently the

case that, as new surgeons join Redlands Hospital's staff, the - 36 -

Redlands Hospital proctoring requirements are satisfied, in whole

or in part, during surgeries performed at the Surgery Center.

Redlands Hospital has been involved in teaching new

procedures to be performed at the Surgery Center. An example is

laser arthroscopic surgery, which eliminates incision. These

procedures were developed at Redlands Hospital, and the knowledge

was shared with the Surgery Center.

The Surgery Center’s Financial Results

The Surgery Center’s profit levels and payor mix are

comparable to other ambulatory surgery centers. Its profits are

used for equipment additions, replacements, improvements in

services, and cash distributions to the partners.

In the first 5-month period after April 30, 1990, when the

amended Operating Partnership and the SCA Management contract

became effective, the Operating Partnership had net income of

$451,430, which was 34.5 percent of gross revenues. SCA

Management received $80,458 in fees.

Cash distributions from the Operating Partnership to

petitioner, SCA Centers, and the limited partners, expressed as

an average rate of return on investment basis for fiscal years

1990-1993, were as follows: - 37 -

Average Rates of Return

FY90 FY91 FY92 FY93 FY90-FY93

Petitioner 6.3% 24.9% 34.9% 43.5% 27.4%

SCA Centers 4.4% 17.3% 25.4% 31.5% 19.6%

Limited Partners 5.1% 21.4% 31.0% 38.5% 24.0%

Upon its Form 1023, Application for Recognition of

Exemption, under section 501(c)(3), filed August 7, 1990,

petitioner estimated that between 50 and 80 percent of its total

annual income would be used to support RHS and Redlands Hospital,

which were stated to have total annual losses of $340,544 and

$460,595, respectively. Petitioner has used its share of the

cash distributions from the Operating Partnership to pay off the

note payable to SCA for its initial capital contribution9 and to

make distributions to RHS or Redlands Hospital.

Final Adverse Ruling

In its final adverse ruling, respondent determined that

petitioner is "not operated exclusively for charitable purposes

within the meaning of section 501(c)(3). You are operating for a

substantial nonexempt purpose and your operations benefit private

interests more than incidentally."

9 The note payable to SCA of $769,829 was paid in full by April 1992. - 38 -

Petitioner has exhausted its administrative remedies within

the Internal Revenue Service.

OPINION

I. The Parties’ Positions

Respondent contends that petitioner is not operated

exclusively for charitable purposes because it operates for the

benefit of private parties and fails to benefit a broad cross-

section of the community. In support of its position, respondent

contends that the partnership agreements and related management

contract are structured to give for-profit interests control over

the Surgery Center. Respondent contends that both before and

after the General Partnership acquired an ownership interest in

it, the Surgery Center was a successful profit-making business

that never held itself out as a charity and never operated as a

charitable health-care provider.

Petitioner argues that it meets the operational test under

section 501(c)(3) because its activities with regard to the

Surgery Center further its purpose of promoting health for the

benefit of the Redlands community, by providing access to an

ambulatory surgery center for all members of the community based

upon medical need rather than ability to pay, and by integrating

the outpatient services of Redlands Hospital and the Surgery

Center. Petitioner argues that its dealings with the for-profit

partners have been at arm's length, and that its influence over - 39 -

the activities of the Surgery Center has been sufficient to

further its charitable goals. Petitioner further contends that

it qualifies for exemption because it is organized and operated

to perform services that are integral to the exempt purposes of

RHS, its tax-exempt parent, and Redlands Hospital, its tax-exempt

affiliate.

II. Applicable Legal Principles

A. Operational Test

To qualify for exemption from Federal income tax, an

organization must be “organized and operated exclusively for

* * * charitable * * * purposes”. Sec. 501(c)(3); see Church of

Scientology v. Commissioner, 823 F.2d 1310, 1315 (9th Cir. 1987),

affg. 83 T.C. 381 (1984).

The applicable regulations provide as follows:

(c) Operational test--(1) Primary activities. An organization will be regarded as “operated exclusively” for one or more exempt purposes only if it engages primarily in activities which accomplish one or more of such exempt purposes specified in section 501(c)(3). An organization will not be so regarded if more than an insubstantial part of its activities is not in furtherance of an exempt purpose. [Sec. 1.501(c)(3)-1(c)(1), Income Tax Regs.]

The operational test focuses on the actual purposes the

organization advances by means of its activities, rather than on

the organization's statement of purpose or the nature of its

activities. See American Campaign Academy v. Commissioner, 92

T.C. 1053, 1064 (1989); Goldsboro Art League, Inc. v. - 40 -

Commissioner, 75 T.C. 337, 343 (1980); Aid to Artisans, Inc. v.

Commissioner, 71 T.C. 202, 210-211 (1978). To determine whether

the operational test has been satisfied, we look beyond “the four

corners of the organization’s charter to discover 'the actual

objects motivating the organization'”. American Campaign Academy

v. Commissioner, supra at 1064.

Although an organization might be engaged in only a single

activity, that single activity might be directed toward multiple

purposes, both exempt and nonexempt. If the nonexempt purpose is

substantial in nature, the organization will not satisfy the

operational test. See KJ’s Fund Raisers, Inc. v. Commissioner,

166 F.3d 1200 (2d Cir. 1998), affg. without published opinion

T.C. Memo. 1997-424; Manning Association v. Commissioner, 93 T.C.

596, 603-605 (1989); American Campaign Academy v. Commissioner,

supra at 1065; Copyright Clearance Ctr., Inc. v. Commissioner, 79

T.C. 793, 804 (1982). “The presence of a single * * * [non-

exempt] purpose, if substantial in nature, will destroy the

exemption regardless of the number or importance of truly * * *

[exempt] purposes.” Better Bus. Bureau, Inc. v. United States,

326 U.S. 279, 283 (1945).

The fact that an organization engages in a trade or business

is not conclusive of a substantial nonexempt purpose and does

not, in and of itself, disqualify the organization from exemption

under section 501(c)(3), provided the activity furthers or - 41 -

accomplishes an exempt purpose. See Federation Pharmacy Servs.,

Inc. v. Commissioner, 72 T.C. 687, 691 (1979), affd. 625 F.2d 804

(8th Cir. 1980); est of Hawaii v. Commissioner, 71 T.C. 1067,

1079 (1979), affd. without published opinion 647 F.2d 170 (9th

Cir. 1981); secs. 1.501(c)(3)-1(c)(1) and 1.501(c)(3)-1(e)(1),

Income Tax Regs.

Whether an organization has a substantial nonexempt purpose

is a question of fact to be resolved on the basis of all the

evidence presented by the administrative record. See B.S.W.

Group, Inc. v. Commissioner, 70 T.C. 352, 357 (1978); see also

Church by Mail, Inc. v. Commissioner, 765 F.2d 1387, 1390 (9th

Cir. 1985), affg. T.C. Memo. 1984-349; est of Hawaii v.

Commissioner, supra at 1079. “Factors such as the particular

manner in which an organization’s activities are conducted, the

commercial hue of those activities, and the existence and amount

of annual or accumulated profits are relevant evidence of a

forbidden predominant purpose.” B.S.W. Group, Inc. v.

Commissioner, supra at 358.

The burden of proof is on petitioner to demonstrate, based

on materials in the administrative record, that it is operated

exclusively for exempt purposes and that it does not benefit

private interests more than incidentally. See Rule 217(c)(2)(A);

Church of Scientology v. Commissioner, 823 F.2d at 1317; Florida

Hosp. Trust Fund v. Commissioner, 103 T.C. 140, 146 (1994), affd. - 42 -

71 F.3d 808 (11th Cir. 1996). For purposes of this proceeding,

we assume that the facts as represented in the administrative

record are true, although in the course of our review we may draw

our own ultimate conclusions and inferences from the facts. See

American Campaign Academy v. Commissioner, supra at 1063-1064;

Houston Lawyer Referral Serv., Inc. v. Commissioner, 69 T.C. 570,

573-575 (1978).

B. Promotion of Health as a Charitable Purpose

Section 501(c)(3) specifies various qualifying exempt

purposes, including “charitable” purposes. The term “charitable”

is not defined in section 501(c)(3), but is used in its generally

accepted legal sense. See Nationalist Movement v. Commissioner,

102 T.C. 558 (1994), affd. per curiam 37 F.3d 216 (5th Cir.

1994); sec. 1.501(c)(3)-1(d)(2), Income Tax Regs. In applying

this standard, courts have looked to the law of charitable

trusts. See Sound Health Association v. Commissioner, 71 T.C.

158, 177 (1978); see also Bob Jones Univ. v. United States, 461

U.S. 574, 588 n.12 (1983).

The promotion of health for the benefit of the community is

a charitable purpose. See Eastern Ky. Welfare Rights Org. v.

Simon, 506 F.2d 1278, 1288-1289 (D.C. Cir. 1974), vacated on

other grounds 426 U.S. 26 (1976); Sound Health Association v.

Commissioner, supra at 177-181; see also 2 Restatement, Trusts

2d, secs. 368, 372 (1959); 4A Scott & Fratcher, Law of Trusts, - 43 -

secs. 368, 372 (4th ed. 1989). As applied to determinations of

qualification for tax exemption, the definition of the term

“charitable” has not been static. See Eastern Ky. Welfare Rights

Org. v. Simon, supra at 1287-1290; Sound Health Association v.

Commissioner, supra. Suffice it to say that, in recognition of

changes in the health-care industry, the standard no longer

requires that “the care of indigent patients be the primary

concern of the charitable hospital, as distinguished from the

care of paying patients”. Sound Health Association v.

Commissioner, supra at 180. Rather, the standard reflects "a

policy of insuring that adequate health care services are

actually delivered to those in the community who need them.” Id.

at 180-181. Under this standard, health-care providers must meet

a flexible community benefit test based upon a variety of

indicia, one of which may be whether the organization provides

free care to indigents. Cf. id. at 184-185 (subsidized dues

program was an indicium of charitable purposes).

To benefit the community, a charity must serve a

sufficiently large and indefinite class; as a corollary to this

rule, private interests must not benefit to any substantial

degree. See id. at 181.

C. Proscription Against Benefiting Private Interests

An organization does not operate exclusively for exempt

purposes if it operates for the benefit of private interests such - 44 -

as designated individuals, the creator or his family,

shareholders of the organization, or persons controlled, directly

or indirectly, by such private interests. See sec. 1.501(c)(3)-

1(d)(1)(ii), Income Tax Regs. The private benefit proscription

inheres in the requirement that an organization operate

exclusively for exempt purposes.

As stated in American Campaign Academy v. Commissioner, 92

T.C. 1053, 1065-1066 (1989):

When an organization operates for the benefit of private interests such as designated individuals, the creator or his family, shareholders of the organization, or persons controlled, directly or indirectly, by such private interests, the organization by definition does not operate exclusively for exempt purposes. Prohibited private benefits may include an “advantage; profit, fruit; privilege; gain; [or] interest.” Occasional economic benefits flowing to persons as an incidental consequence of an organization pursuing exempt charitable purposes will not generally constitute prohibited private benefits. Thus, should * * * [the organization] be shown to benefit private interests, it will be deemed to further a nonexempt purpose under section 1.501(c)(3)-1(d)(1)(ii), Income Tax Regs. This nonexempt purpose will prevent [the organization] from operating primarily for exempt purposes absent a showing that no more than an insubstantial part of its activities further the private interests or any other nonexempt purposes. [Citations and fn. ref. omitted.]

The proscription against private benefit shares common

elements with, but is distinct from, the proscription against the

inurement of organizational earnings to private shareholders and

individuals, as contained in section 501(c)(3) and sections

1.501(a)-1(c) and 1.501(c)(3)-1(c)(2), Income Tax Regs. See - 45 -

American Campaign Academy v. Commissioner, supra at 1068. The

proscription against private benefit encompasses not only

benefits conferred on insiders having a personal and private

interest in the organization, but also benefits conferred on

unrelated or disinterested persons. See id.; Christian

Stewardship Assistance, Inc. v. Commissioner, 70 T.C. 1037

(1978).

The mere fact that an organization seeking exemption enters

into a partnership agreement with private parties that receive

returns on their capital investments does not establish that the

organization has impermissibly conferred private benefit. The

question remains whether the organization has a substantial

nonexempt purpose whereby it serves private interests. Compare

Plumstead Theatre Socy., Inc. v. Commissioner, 675 F.2d 244 (9th

Cir. 1982), affg. per curiam 74 T.C. 1324 (1980) (a nonprofit

arts organization furthered its charitable purposes by

participating as sole general partner in a partnership with

private parties to produce a play), with Housing Pioneers, Inc.

v. Commissioner, 49 F.3d 1395 (9th Cir. 1995), affg. T.C. Memo.

1993-120 (a nonprofit corporation’s participation as co-general

partner in low-income housing partnerships, structured to trade

off its tax exemption to secure tax benefits for its for-profit

partners, had a substantial nonexempt purpose and impermissibly

served private interests). - 46 -

The proscription against private benefit corresponds to a

similar proscription in the law of charitable trusts. “A trust

is not a charitable trust if the property or the income therefrom

is to be devoted to a private use.” 2 Restatement, Trusts 2d,

sec. 376 (1959). An organization’s property may be impermissibly

devoted to a private use where private interests have control,

directly or indirectly, over its assets, and thereby secure

nonincidental private benefits.

For instance, in est of Hawaii v. Commissioner, 71 T.C. 1067

(1979), several for-profit ‘est’ organizations that had no formal

structural control over the nonprofit entity in question

nevertheless exerted "considerable control" over its activities.

The for-profit organizations set fees that the nonprofit charged

the public for training sessions, required the nonprofit to carry

on certain types of educational activities, and provided

management personnel paid for and responsible to one of the for-

profits. Under a licensing agreement with the for-profits, the

nonprofit was allowed to use certain intellectual property for 10

years, and at the end of the licensing agreement, all copyrighted

material, including new material developed by the nonprofit, was

required to be turned over to the for-profits. The nonprofit was

required to use its excess funds for the development of ‘est’ or

related research. The for-profits also required that trainers

and local organizations sign an agreement not to compete with - 47 -

‘est’ for 2 years after terminating their relationship with ‘est’

organizations.

In est of Hawaii v. Commissioner, supra at 1080, this Court

agreed with respondent that the nonprofit was “part of a

franchise system which is operated for private benefit and * * *

its affiliation with this system taints it with a substantial

commercial purpose.” We found that the “ultimate beneficiaries”

of the nonprofit’s activities were the for-profit corporations,

and that the nonprofit “was simply the instrument to subsidize

the for-profit corporations and not vice versa”. Id. at 1082.

This Court held that the nonprofit was not operated exclusively

for exempt purposes. See also Harding Hosp., Inc. v. United

States, 505 F.2d 1068 (6th Cir. 1974) (impermissible private

benefit resulted from a nonprofit hospital's contract with a

physician group, giving them a virtual monopoly over care of the

hospital's patients and the income stream they represented, and

providing the physician group with fees for supervising the

hospital's medical staff); Sonora Community Hosp. v.

Commissioner, 46 T.C. 519 (1966) (impermissible private benefit

resulted from an arrangement whereby a for-profit laboratory was

permitted to occupy space in the nonprofit hospital rent-free,

and paid the hospital’s founding doctors a share of the

laboratory’s gross revenues in consideration of patient referrals

and administrative services), affd. 397 F.2d 814 (9th Cir. 1968). - 48 -

III. Petitioner’s Claim to Exemption on a “Stand-Alone” Basis

Applying the principles described above, we next consider

whether petitioner has established that respondent improperly

denied it tax-exempt status as a section 501(c)(3) organization.

A. The Relevance of Control--The Parties’ Positions

Respondent asserts that petitioner has ceded effective

control over its sole activity--participating as a co-general

partner with for-profit parties in the partnerships that own and

operate the Surgery Center--to the for-profit partners and the

for-profit management company that is an affiliate of

petitioner’s co-general partner. Respondent asserts that this

arrangement is indicative of a substantial nonexempt purpose,

whereby petitioner impermissibly benefits private interests.

Without conceding that private parties control its

activities, petitioner challenges the premise that the ability to

control its activities determines its purposes. Petitioner

argues that under the operational test, “the critical issue in

determining whether an organization’s purposes are noncharitable

is not whether a for profit or not for profit entity has control.

Rather, the critical issue is the sort of conduct in which the

organization is actually engaged.” On brief, the parties agree

that under an aggregate theory of partnership taxation, the

partnerships’ activities are considered petitioner’s own - 49 -

activities. Petitioner’s brief states: “The evidence in the

administrative file demonstrates that * * * [the Operating

Partnership] has been operated in an exclusively charitable

manner since 1990". Therefore, petitioner concludes, it should

be deemed to operate exclusively for charitable purposes.

We disagree with petitioner’s thesis. It is patently clear

that the Operating Partnership, whatever charitable benefits it

may produce, is not operated “in an exclusively charitable

manner”. As stated by Justice Cardozo (then Justice of the New

York Court of Appeals), in describing one of the “ancient

principles” of charitable trusts, “It is only when income may be

applied to the profit of the founders that business has a

beginning and charity an end.” Butterworth v. Keeler, 219 N.Y.

446, 449-450, 114 N.E. 803, 804 (1916). The Operating

Partnership's income is, of course, applied to the profit of

petitioner’s co-general partner and the numerous limited

partners.10 It is no answer to say that none of petitioner’s

income from this activity was applied to private interests, for

the activity is indivisible, and no discrete part of the

Operating Partnership's income-producing activities is severable

10 In making these observations, we are mindful that it is the status of petitioner, not of the General Partnership or the Operating Partnership, that is in issue. Indeed, it is not meaningful to speak of a partnership’s exempt status, given that partnerships are nontaxable entities. See sec. 701. - 50 -

from those activities that produce income to be applied to the

other partners’ profit.

Taken to its logical conclusion, petitioner’s thesis would

suggest that an organization whose main activity is passive

participation in a for-profit health-service enterprise could

thereby be deemed to be operating exclusively for charitable

purposes. Such a conclusion, however, would be contrary to well-

established principles of charitable trust law.

Frequently, a business enterprise may have charitable effects. * * * A private hospital relieves sickness and suffering. * * * However, the primary object of these institutions is the pecuniary gain of the operators. Hence trusts to aid in the founding or maintenance of private hospitals or clinics * * *, which are business enterprises operated for the purpose of making profits for stockholders or owners, are not charitable even though they involve incidentally some public benefits. “It is not charity to aid a business enterprise.” [Bogert & Bogert, The Law of Trusts and Trustees, sec. 364 (Rev. 2d ed. 1991) (quoting Butterworth v. Keeler, 219 N.Y. at 449, 114 N.E. at 804); fn. refs. omitted.]

Clearly, there is something in common between the structure

of petitioner’s sole activity and the nature of petitioner’s

purposes in engaging in it. An organization’s purposes may be

inferred from its manner of operations; its “activities provide a

useful indicia of the organization’s purpose or purposes.”

Living Faith, Inc. v. Commissioner, 950 F.2d 365, 372 (7th Cir.

1991), affg. T.C. Memo. 1990-484. The binding commitments that

petitioner has entered into and that govern its participation in

the partnerships are indicative of petitioner’s purposes. To the - 51 -

extent that petitioner cedes control over its sole activity to

for-profit parties having an independent economic interest in the

same activity and having no obligation to put charitable purposes

ahead of profit-making objectives, petitioner cannot be assured

that the partnerships will in fact be operated in furtherance of

charitable purposes. In such a circumstance, we are led to the

conclusion that petitioner is not operated exclusively for

charitable purposes.

Based on the totality of factors described below, we

conclude that petitioner has in fact ceded effective control of

the partnerships’ and the Surgery Center’s activities to for-

profit parties, conferring on them significant private benefits,

and therefore is not operated exclusively for charitable purposes

within the meaning of section 501(c)(3).

B. Indicia of For-Profit Control Over the Partnerships’ Activities

1. No Charitable Obligation

Nothing in the General Partnership agreement, or in any of

the other binding commitments relating to the operation of the

Surgery Center, establishes any obligation that charitable

purposes be put ahead of economic objectives in the Surgery

Center’s operations. The General Partnership agreement does not - 52 -

expressly state any mutually agreed-upon charitable purpose or

objective of the partnership.11

After the General Partnership acquired its 61-percent

interest, the Operating Partnership--which had long operated as a

successful for-profit enterprise and never held itself out as a

charity--never changed its organizing documents to acknowledge a

charitable purpose. Indeed, in at least one instance the

Operating Partnership agreement explicitly acknowledges the

partnership’s noncharitable objectives. Section 16.5.2 of the

Operating Partnership agreement, supra, in authorizing the

General Partnership to amend the Operating Partnership as

necessary to comply with legal requirements, specifies that this

authority may be exercised only if “such amendments do not alter

the economic objectives of the partnership or materially reduce

the economic return to the limited partners.”

11 The prefatory “Whereas” clauses to the General Partnership agreement recite that RHS is entering into the agreement to “insure the availability of high quality health services in the most cost effective setting in which such services can be rendered” and because “the use of an ambulatory surgical center will contribute to RHS’s goal of providing comprehensive health care services at an affordable price.” The partnership agreement, however, does not reflect that this was a mutual premise. The partnership agreement states as the purpose of the partnership merely the acquiring of a 61-percent interest in the Operating Partnership, stating that the General 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.” - 53 -

2. Petitioner’s Lack of Formal Control

a. Managing Directors

Under the General Partnership agreement, control over all

matters other than medical standards and policies is nominally

divided equally between petitioner and SCA Centers, each

appointing two representatives to serve as managing directors.

(As discussed infra, matters of medical standards and policies

are determined by the Medical Advisory Group, half of whom are

chosen by the General Partnership’s managing directors.)

Consequently, petitioner may exert influence by blocking actions

proposed to be taken by the managing directors, but it cannot

initiate action without the consent of at least one of SCA

Center’s appointees to the managing directors. For instance,

petitioner lacks sufficient control unilaterally to cause the

Surgery Center to respond to community needs for new health

services, modify the delivery or cost structure of its present

health services to serve the community better, or, as discussed

in more detail infra, terminate SCA Management, if SCA Management

were determined to be managing the Surgery Center in a manner

inconsistent with charitable objectives.

The administrative record shows that petitioner has

successfully blocked various proposals to expand the scope of

activities performed at the Surgery Center. Petitioner’s ability

to veto expansion of the scope of the Surgery Center’s - 54 -

activities, however, does not establish that petitioner has

effective control over the manner in which the Surgery Center

conducts activities within its predesignated sphere of

operations. Nor does it tend to indicate that the Surgery Center

is not operated to maximize profits with regard to those

activities. Indeed, given that all the partners except

petitioner are for-profit interests not shown to be motivated or

constrained by charitable objectives, and given that all the

limited partners except Beaver Medical Clinic were issued SCA

common stock when the General Partnership acquired its interest

in the Operating Partnership, and given that SCA Management

derives a management fee computed as a percentage of gross

revenues, we find, in the absence of evidence to the contrary,

that a significant profit-making objective is present in the

Surgery Center’s operations. The high rates of return earned on

the partners’ investments (including petitioner’s) in the

Operating Partnership bolster this finding.

In sum, the composition of the managing directorship

evidences a lack of majority control by petitioner whereby it

might assure that the Surgery Center is operated for charitable

purposes.12 Consequently, we look to the binding commitments

12 The managing directors of the General Partnership are functionally equivalent to a hospital's board of directors, the importance of which has been described as follows:

(continued...) - 55 -

made between petitioner and the other parties to ascertain

whether other specific powers or rights conferred upon petitioner

might mitigate or compensate for its lack of majority control.

b. Arbitration Process

The General Partnership agreement provides for an

arbitration process in the event that the managing directors of

the General Partnership deadlock over a matter other than medical

standards and medical policies, such as approval of new surgical

procedures. Under these provisions, in the event of a deadlock,

each of the co-general partners selects one arbitrator, and these

two arbitrators select a third. The arbitrators have final

authority to decide matters referred to them. The ground rules

for the arbitration process are minimal and provide petitioner no

assurance that charitable objectives will govern the outcome.

Under the General Partnership agreement, the arbitrators are not

required to take into account any charitable or community benefit

12 (...continued) The board of directors, its composition, and its functions are relevant to tax exemption * * * the composition of the board provides important evidence that the hospital serves public rather than private purposes. For example, it is fair to presume that a board of directors chosen from the community would place the interests of the community above those of either the management or the medical staff of the hospital. Thus, the relevance of the board is that its process should indicate whether the hospital is operated for the benefit of the community or to secure benefits for private interests. [Mancino, “Income Tax Exemption of the Contemporary Nonprofit Hospital”, 32 St. Louis U.L.J. 1015, 1051 (1988).] - 56 -

objective, but are simply required to “apply the substantive law

of California”.

Petitioner asserts that since 1990, neither co-general

partner has invoked the arbitration clause. The administrative

record is inconclusive on this point. Even assuming arguendo

that petitioner’s assertion is correct, it merely tends to show

that petitioner and SCA Centers have avoided conflict with regard

to those operating decisions that are subject to arbitration.

Whether such conflicts have been avoided because petitioner’s

purposes and the purposes of its for-profit partner are so

closely aligned, or for some other reason, the administrative

record does not reveal. Clearly, however, the arbitration

process does not significantly mitigate petitioner’s lack of

majority control to provide any assurance that the General

Partnership will operate to put charitable objectives ahead of

economic objectives.

c. The Management Contract

The management contract between the Operating Partnership

and SCA Management confers broad powers on SCA Management to

enter into contracts, to negotiate with third-party payers and

State and Federal agencies, and to set patient charges for all

services provided, with the exception of charges for physicians’

services. In short, SCA Management is authorized to manage as it

sees fit many of the day-to-day operations of the Surgery Center, - 57 -

reserving to the Medical Advisory Group of the Operating

Partnership the authority to make all medical decisions.

receive fees equaling 6 percent of the Operating Partnership’s

gross revenues each month, in addition to reimbursement of its

direct expenses. This revenue-based compensation structure

provides SCA Management an incentive to manage the Surgery Center

so as to maximize profits.13

As a practical matter, the Operating Partnership is locked

into the management agreement with SCA Management for at least 15

years. At its sole discretion, SCA Management may renew the

agreement for two additional 5-year periods on the same terms and

conditions. The Operating Partnership has the right to terminate

the management contract for breach, but only after the Operating

Partnership has given written notice describing in detail the

13 The management contract defines gross revenues as “the net collectable portion of revenues billed as fees or other charges arising out of the operation of the [Surgery] Center, with no deduction for bad debts.” Petitioner suggests on brief that this means that SCA Management has no disincentive to treat patients who are unable to pay for treatment, because the “gross revenues” on which its management fee is based would include the chargeable amount for the services rendered. We do not find these arguments convincing. In the first instance, the Surgery Center does not provide charity care. Moreover, petitioner’s argument does not address to what extent charitable services, if they were provided, would give rise to “net collectable * * * revenues”. Nor does petitioner’s argument address the broader point that the management contract gives SCA Management an economic interest to maximize revenues in all aspects of the Surgery Center’s operations, and not just as relate to charity care. - 58 -

basis on which it believes termination is justified. Because the

issuance of such a termination notice would require approval by a

majority of the General Partner’s managing directors, petitioner

could not effect the issuance of such a notice without the

consent of SCA Centers, which is an affiliate of SCA Management.

Thus, even if petitioner determined that SCA Management were

managing the Surgery Center in a manner inconsistent with

charitable purposes, petitioner could not be assured of any

remedy.

Moreover, neither the General Partnership agreement, the

Operating Partnership agreement, nor the management contract

itself requires that SCA Management be guided by any charitable

or community benefit, goal, policy, or objective. Rather, the

management contract simply requires SCA Management to render

services as necessary and in the best interest of the Operating

Partnership, “subject to the policies established by [the

Operating Partnership], which policies shall be consistent with

applicable state and Federal law.”

Petitioner argues that the management contract “was

negotiated at arm’s length, between parties of equal bargaining

strength”. The administrative record does not support this

contention. Although the General Partnership agreement was

negotiated between RHS and SCA Centers, it contains only a sparse

description of several key features to be included in the - 59 -

management contract.14 The actual management contract is between

SCA Management and the Operating Partnership, and contains much

more extensive and detailed provisions than are stipulated in the

General Partnership agreement. Notably, the term of the

management agreement is at variance with the term stipulated in

the General Partnership agreement.15

The administrative record does not reveal that petitioner or

RHS had any role in negotiating the actual management contract.

It is executed for both the Operating Partnership and SCA

Management by the same individual--David E. Crockett--in his dual

capacities as secretary of SCA Centers and vice president of SCA

Management, raising the suggestion, if not the likelihood, of

self-dealing between these two SCA affiliates.

Respondent asserts, and we agree, that this long-term

management contract with an affiliate of SCA Centers is a salient

indicator of petitioner's surrender of effective control over the

14 The General Partnership agreement merely provides that SCA Management will assume “full responsibility for administering the day-to-day operation of the ambulatory center in accordance with the goals, policies and objectives” of the Operating Partnership, and stipulates an initial 15-year term, renewable for two 5-year terms, and a fee equal to 6 percent of the Operating Partnership’s gross revenues. 15 Whereas the General Partnership agreement stipulates a 15-year initial term for the management contract, the actual management contract modifies this provision to the advantage of SCA and its affiliates by providing that the initial term is equal to the term of any indebtedness, lease, or other obligation of the Operating Partnership guaranteed by SCA or SCA’s affiliate, but not less than 15 years. - 60 -

Surgery Center’s operations to SCA affiliates, whereby the

affiliates were given the ability and incentive to operate the

Surgery Center so as to maximize profits. This surrender of

effective control reflects adversely on petitioner's own

charitable purposes in contracting to have its sole activity

managed in this fashion. Cf. est of Hawaii v. Commissioner, 71

T.C. 1067 (1979).

d. Medical Advisory Group

The Operating Partnership agreement delegates authority for

making decisions about care and treatment of patients and other

medical matters to the Operating Partnership’s Medical Advisory

Group. This group was inactive before the General Partnership

became involved with the Operating Partnership, but there is no

evidence to show what role, if any, petitioner played in

reconstituting the Medical Advisory Group.

Only three of the six members of the Medical Advisory Group

are selected by the General Partnership. The other three are

selected by one of the limited partners, Beaver Medical Clinic.

It is telling that the Medical Advisory Group is composed

entirely of limited partners of the Operating Partnership, all of

whom (except Beaver Medical Clinic) received common stock in SCA

when the General Partnership acquired its Operating Partnership

interest. Taking all these considerations into account, it is

clear that petitioner lacks sufficient influence to determine the - 61 -

resolution of any matter brought before the Medical Advisory

Group. Moreover, there is no evidence in the record that the

decisions of the Medical Advisory Committee are subject to

independent review by petitioner or Redlands Hospital.

e. Termination of Quality Assurance Activities

As required by the General Partnership agreement, on April

30, 1990, SCA Management entered into a quality assurance

agreement with RHS. The term of the quality assurance agreement

was conditioned on maintenance of a specified level of surgery

activity in the Surgery Center. Petitioner concedes that the

quality assurance agreement terminated after the first year.16

Although the agreement required the parties to negotiate a new

quality assurance agreement in the event of such a termination,

there is no evidence in the record that such negotiations ever

occurred.17

The termination of the quality assurance agreement vividly

evidences petitioner’s lack of effective control over vital

aspects of the Surgery Center’s operations. Quality assurance

16 The termination of the quality assurance agreement is disclosed in petitioner's reply brief, filed on May 11, 1998. Petitioner's counsel represent that the fact of the termination of the quality assurance agreement was first disclosed to them on or about Apr. 30, 1998. 17 Under the quality assurance agreement, petitioner was entitled to a fee equal to 1 percent of gross revenues, commencing in the second year. Because the agreement terminated after the first year, it appears that petitioner never received any fees under the agreement. - 62 -

agreements in the health-care industry serve the important dual

functions of attempting to avoid inappropriate services (e.g.,

the wrong services for the patient’s needs, or services that are

improperly rendered), and seeking to assure that enough services

are provided to meet the patient’s needs. See 2 National Health

Lawyers Association, Health Law Practice Guide, sec. 25.1, at 25-

3 (1997). The record does not reflect that petitioner performed

any quality assurance work. Likewise, the record is silent as to

how petitioner, in the absence of any operable quality assurance

agreement, purports to assure itself that these vital functions

will be discharged consistently with charitable objectives.

3. Lack of Informal Control

The administrative record provides no basis for concluding

that, in the absence of formal control, petitioner possesses

significant informal control by which it exercises its influence

with regard to the Surgery Center’s activities. Nothing in the

administrative record suggests that petitioner commands

allegiance or loyalty of the SCA affiliates or of the limited

partners to cause them to put charitable objectives ahead of

their own economic objectives. Indeed, until April 1992,

petitioner was in a debtor relationship to SCA. The limited

partners (except for Beaver Medical Clinic, Inc.) all became

common stockholders of SCA when the General Partnership acquired

its interest in the Operating Partnership. - 63 -

The administrative record does not establish that petitioner

has the resources or ability effectively to oversee or monitor

the Surgery Center’s operations. Petitioner has almost no

resources apart from its assets invested in the General

Partnership. The president of Redlands Hospital also serves as

petitioner’s president and as one of the four managing directors

of the General Partnership.

On brief, petitioner argues that its influence in the

partnerships is evidenced by various changes that it says

occurred in the operation of the Surgery Center after April 1990,

when the amended Operating Partnership agreement became

effective. Petitioner suggests that these operational changes

demonstrate that its influence is sufficient to allow it to

achieve its charitable goals through the partnerships' activities

and demonstrate that for-profit interests do not control the

partnerships and the Surgery Center. As described in more detail

below, the record does not support petitioner’s contentions.

a. Change in Criteria for Procedures Performed at the Surgery Center

Petitioner asserts that after the General Partnership

acquired its interest in the Operating Partnership, “the decision

to perform a surgery at the Surgery Center was changed from an

economic to exclusively a medical decision. Accordingly, RHS

achieved its goal of providing complete access to freestanding - 64 -

ambulatory surgery center care for all members of the Redlands

community irrespective of their ability to pay.”

This proposed finding of fact is not supported by the

record. Neither before nor after petitioner’s involvement with

it has the Surgery Center provided charity care. Moreover, the

administrative record indicates that one aspect of ambulatory

surgery centers that makes them attractive investment

opportunities in the first instance is that they boast favorable

“procedure and payer mixes”.18 Consequently, it is not apparent

from the record to what extent the decision to perform a surgery

at the Surgery Center has ever been an “economic” rather than a

“medical” decision, or exactly how that situation might have

changed after April 1990.

Even if we assume, arguendo, that a change in criteria did

occur after April 1990, the record does not establish

petitioner’s role in effecting any such change.

18 The administrative record includes an investment summary with respect to SCA and another national health-care provider, Medical Care International, published by Shearson Lehman Brothers, dated Aug. 7, 1991. The report states: “To a large extent the favorable payer mix is a function of the fact that many procedures safely performed on an outpatient basis happen to be those with a young patient population.” Similarly, in its arguments to justify the Surgery Center’s low rate of Medi-Cal patients, petitioner notes that the Surgery Center does not perform the types of procedures--emergency room treatments and obstetrics and gynecology--that typically account for a "substantial majority" of low-income surgical expenses for a community. - 65 -

b. Provision for Indigent Patients

Petitioner concedes that as of December 31, 1993, Medi-Cal

patients accounted for only 0.8 percent of total procedures

performed at the Surgery Center. Petitioner argues that the type

of services which the Service Center offers is not the type of

services typically sought by low-income individuals. Petitioner

notes that Redlands Hospital has negotiated certain provider

agreements that designate the Surgery Center as a subcontractor

to provide outpatient services for Medi-Cal patients, and that

Redlands Hospital has caused the Surgery Center to increase its

number of managed care contracts. Petitioner suggests that these

efforts demonstrate petitioner’s influence over the operations of

the Surgery Center and evidence petitioner's charitable purposes.

We do not find petitioner’s arguments convincing. The facts

remain that the Surgery Center provides no free care to indigents

and only negligible coverage for Medi-Cal patients. That low-

income individuals may not typically seek the types of services

the Surgery Center offers may partially explain the virtual

absence of relief it provides for such individuals. But it

provides no independent basis for establishing petitioner’s

charitable purposes in its involvement with the Surgery Center.

Moreover, the activities of Redlands Hospital in effecting some

negligible degree of Medi-Cal coverage at the Surgery Center and

in increasing the number of managed care contracts do not provide - 66 -

a basis for establishing petitioner's exemption. Cf. Harding

Hosp., Inc. v. United States, 505 F.2d 1068 (6th Cir. 1974)

(activities performed by third parties did not provide a basis

for organization’s exemption).

Petitioner asserts that the Surgery Center has no

requirement that patients demonstrate an ability to pay before

receiving treatment. The record does not reflect whether any

such policy has been communicated to its patients. Petitioner

suggests that this policy is evidenced by the Surgery Center’s

“substantial Medicare” patronage. The record shows that Medicare

accounted for 12 percent of invoices at the Surgery Center in the

last half of 1993. The record does not reflect, however, whether

the Surgery Center waives fees in excess of those covered by

Medicare and accordingly does not establish that ability to pay

is not a factor even for patients covered by Medicare. Moreover,

the Surgery Center’s treatment of Medicare patients cannot on

this record be attributed to petitioner’s influence over the

Surgery Center’s operations. According to the affidavit of Mr.

James R. Holmes, who was president of petitioner and Redlands

Hospital at the time of the affidavit, the Surgery Center “has

regularly treated Medicare patients * * * since before 1990.” - 67 -

c. Coordination of Activities of Redlands Hospital and the Surgery Center

In arguing that it plays an active role in the conduct of

the Surgery Center’s activities, petitioner cites a number of

ways in which Redlands Hospital has integrated its activities

with those of the Surgery Center since the General Partnership

acquired its interest in the Operating Partnership. These

include Redlands Hospital’s use of the Surgery Center as a site

for training and surgeon proctoring, as well as various other

cooperative training and educational activities between Redlands

Hospital and the Surgery Center.19

Although there may be cooperation between the Surgery Center

and Redlands Hospital, nothing in the record suggests that these

various cooperative activities are more than incidental to the

for-profit orientation of the Surgery Center’s activities. Cf.

Harding Hosp., Inc. v. United States, supra at 1075-1076

19 The administrative record contains unexplained inconsistencies regarding certain of these training procedures. On the one hand, a letter in the administrative record, dated Nov. 23, 1994, from Ernst & Young to respondent’s representative, cites laproscopic cholecystectomy (gall bladder surgery) as an example of a new procedure that Redlands Hospital was extensively involved in teaching to physicians using the Surgery Center. On the other hand, an affidavit of Gary J. Cottingham, president of RHS and Redlands Hospital from Sept. 22, 1987, to May 12, 1995, states that SCA Centers requested that the Surgery Center begin to perform outpatient cholecystectomies at the Surgery Center, but that the General Partnership’s managing directors rejected the proposal. Mr. Cottingham’s affidavit states: “At least through May 1995, * * * Outpatient cholecystectomies were not performed at [the Surgery Center].” - 68 -

(educational, training and community-oriented programs conducted

at a hospital and funded by a third party were not sufficient to

merit the hospital’s tax exemption where other disqualifying

factors were present).

C. Competitive Restrictions and Market Advantages

By entering into the General Partnership agreement, RHS

(petitioner's parent corporation and predecessor in interest in

the General Partnership) not only acquired an interest in the

Surgery Center, but also restricted its future ability to provide

outpatient services at Redlands Hospital or elsewhere without the

approval of its for-profit partner. Paragraph 16 of the General

Partnership agreement, supra, prohibits the co-general partners

and their affiliates from owning, managing, or developing another

freestanding outpatient surgery center within 20 miles of the

Surgery Center, without the other partner’s consent. Moreover,

Redlands Hospital may not “expand or promote its present

outpatient surgery program within the Hospital.” In fact,

outpatient surgeries performed at Redlands Hospital decreased

about 17 percent from 1990 to 1995, while those performed at the

Surgery Center increased.

The General Partnership agreement also restricts the parties

and their affiliates from providing outpatient surgery services

and procedures that the agreement does not specifically authorize

to be provided at the Surgery Center (hereinafter referred to as - 69 -

nonlisted services). Under this agreement, Redlands Hospital,

but not the co-general partners or any of their other affiliates,

is allowed to perform nonlisted outpatient services that were

currently available to patients in California at the time the

General Partnership agreement was executed. By contrast, neither

Redlands Hospital nor the co-general partners or their affiliates

are allowed to perform nonlisted outpatient services that first

become available in California during the term of the General

Partnership agreement (i.e., until March 31, 2020), unless the

managing directors of the General Partnership approve.20

Consequently, RHS effectively restricted its own ability to

assess and service community needs for outpatient services until

the year 2020. It is difficult to conceive of a significant

charitable purpose that would be furthered by such a restriction.

The administrative record contains a market research report

on the ambulatory surgery center industry, prepared by Ernst &

Young and transmitted to Redlands Hospital on October 20, 1994.

This report describes the strong movement toward providing health

care services in ambulatory settings, driven both by economic

considerations and technological advances.21 The report notes

20 As previously discussed, petitioner lacks sufficient control to dictate any such approval by the managing directors, and, in the event of deadlock, the matter would go to arbitration. 21 The report states that during the 1980's, hospital-based (continued...) - 70 -

that hospitals face “strong competition” in this market. It

cites economic advantages that freestanding ambulatory surgery

centers enjoy over hospitals. These advantages include, among

other things, higher turn-over of operating rooms that increases

the number of “fee-generating procedures” surgeons can do; lower

nurse compensation that in turn leads to “higher margins”; and

the “general tendency for private payers to account for a high

percentage of a surgery center’s mix, since most procedures

performed in outpatient settings are elective (nonemergency) and

are done on younger, non-Medicare patients.” The report cites

physician relations and capital as two major barriers to entering

this market.

The Shearson Lehman Brothers investment summary, see supra

note 18, contains similar facts and conclusions. The report

indicates that SCA and Medical Care International are the two

main surgical center chains, that they are highly profitable, and

that their margins are likely to continue moving higher. The

report notes that one reason for the high profitability of these

chains is that “they typically shadow-price hospitals, which tend

21 (...continued) outpatient surgeries grew from 3 million in 1980 to 11 million in 1990, and that nonhospital-based surgery volume increased even faster, experiencing a 21.1-percent growth in procedures between 1989 and 1990 alone. The report projects continued growth in this industry, stating: “The expansion of ambulatory surgery service centers is likely to be accelerated by economic incentives * * * as well as new technological developments.” - 71 -

to charge very high rates for outpatient surgery so they can

shift costs to the private sector and spread out their overhead.”

The report states that “one might expect hospitals to fight hard

for this business by starting up their own FASCs [freestanding

ambulatory surgery centers]”, but that this had not happened to

date because it is very hard for hospitals to do so, due partly

to problems hospitals face in throwing off their own “culture”

and creating an autonomous unit that is small, friendly, and

efficient. The report states: “[SCA’s] strategy of developing

three-way joint ventures--consisting of a local hospital,

surgeons, and the company--represents an attractive opportunity

to address these cultural problems.” The report notes:

the FASC niche of the health care services industry has the further attraction of considerable consolidation opportunity. We believe that multispecialty, nonhospital FASCs currently number 600-700, with perhaps another 100 opening each year. Yet there are currently only two chains, Medical Care International and [SCA] affiliates, which have a total of 109 units. * * *

Once a surgical group decides to sell its center, there is generally only one bidder (Medical Care or [SCA]), with the price typically five to seven times pretax income. * * * The key issue for MDs is not the modest amount of cash that comes from a sale but the operating environment for them once the center changes hands.

In the instant case, the Surgery Center had not one but two

bidders, the General Partnership, offering four to five times

earnings, and another unrelated, for-profit bidder, otherwise

unidentified in the record, offering approximately six times - 72 -

earnings. A letter from Ernst & Young to respondent’s

representatives, dated July 14, 1992, indicates that the Surgery

Center took the General Partnership’s offer instead of the other,

higher bid because of a desire to have an affiliation with

Redlands Hospital for quality control and other reasons.

Viewed in its totality, the administrative record is clear

that SCA and petitioner derive mutual economic benefits from the

General Partnership agreement. By borrowing necessary up-front

capital from SCA, RHS (petitioner's predecessor in interest in

the General Partnership), overcame a capital barrier to gain

entry into a profitable and growing market niche. By forming a

partnership with RHS, SCA Centers was able to benefit from the

established relationship between Redlands Hospital and the

limited partner physicians to acquire its interest in the Surgery

Center at a bargain price.

By virtue of this arrangement, petitioner and SCA Centers

realized further mutual benefits by eliminating sources of

potential competition for patients, as is evidenced by the

restrictions on either party’s providing future outpatient

services outside the Surgery Center, and by Redlands Hospital’s

agreeing not to expand or promote its existing outpatient surgery

facility at the hospital. In light of the statement in the

record that it is typical for national chains such as SCA to

“shadow-price” hospitals in charging for services at outpatient - 73 -

surgery centers, it seems most likely that one purpose and effect

of the containment and contraction of Redlands Hospital’s

outpatient surgery activities is to eliminate a competitive

constraint for setting Surgery Center fees (a matter delegated to

SCA Management under the management contract, excluding charges

for physicians’ services). Moreover, market consolidation

provided petitioner and SCA Centers mutual advantages by

eliminating pressures to compete in spending for expensive

equipment.22

There is no per se proscription against a nonprofit

organization's entering into contracts with private parties to

further its charitable purposes on mutually beneficial terms, so

long as the nonprofit organization does not thereby impermissibly

serve private interests. Cf. Plumstead Theatre Socy. v.

Commissioner, 75 F.2d 244 (9th Cir. 1982); Broadway Theatre

League v. United States, 293 F. Supp. 346 (W.D. Va. 1968). In

the instant case, however, RHS relied on the established

relationship between Redlands Hospital and Redlands physicians to

enable RHS and SCA affiliates jointly to gain foothold, on

favorable terms, in the Redlands ambulatory surgery market.

Then, by virtue of their effective control over the Surgery

22 As stated in a letter in the administrative record written on behalf of petitioner from Ernst & Young LLP to respondent, dated Nov. 23, 1994, “The Hospital and * * * [the Surgery Center] also share surgical equipment so as to avoid a ‘medical arms race’ in the Redlands health care community.” - 74 -

Center, the SCA affiliates have been enabled to operate it as a

profit-making business, with significantly reduced competitive

pressures from Redlands Hospital, and largely unfettered by

charitable objectives that might conflict with purely commercial

objectives. Cf. est of Hawaii v. Commissioner, 71 T.C. 1067,

1080 (1979); Housing Pioneers, Inc. v. Commissioner, T.C. Memo.

1993-120, affd. 49 F.3d 1395 (9th Cir. 1995). The net result to

the SCA affiliates is a nonincidental "advantage; profit; fruit;

privilege; gain; [or] interest" that constitutes a prohibited

private benefit. See American Campaign Academy v. Commissioner,

92 T.C. 1053, 1065 (1989).

D. Conclusion

Based on all the facts and circumstances, we hold that

petitioner has not established that it operates exclusively for

exempt purposes within the meaning of section 501(c)(3). In

reaching this holding, we do not view any one factor as crucial,

but we have considered these factors in their totality: The lack

of any express or implied obligation of the for-profit interests

involved in petitioner's sole activity to put charitable

objectives ahead of noncharitable objectives; petitioner's lack

of voting control over the General Partnership; petitioner's lack

of other formal or informal control sufficient to ensure

furtherance of charitable purposes; the long-term contract giving

SCA Management control over day-to-day operations as well as a - 75 -

profit-maximizing incentive; and the market advantages and

competitive benefits secured by the SCA affiliates as the result

of this arrangement with petitioner. Taken in their totality,

these factors compel the conclusion that by ceding effective

control over its operations to for-profit parties, petitioner

impermissibly serves private interests.

IV. Petitioner’s Claim to Exemption Under the Integral Part Doctrine

Petitioner argues that even if it does not qualify for tax

exemption on a “stand alone” basis, it qualifies for exemption

under the integral part doctrine.

The integral part doctrine is not codified, but rather is

the outgrowth of judicial opinions, rulings, and regulations.

The precise contours of this doctrine are not clearly defined.

The seminal case of Squire v. Students Book Corp., 191 F.2d 1018

(9th Cir. 1951), held that an organization that operated a

bookstore on the premises of a college for the accommodation of

students and faculty was exempt because it bore a “close and

intimate relationship” to the functioning of the college itself.

See also Brundage v. Commissioner, 54 T.C. 1468 (1970); Estate of

Thayer v. Commissioner, 24 T.C. 384 (1955).

Shortly after the decision in Squire, Treasury regulations

acknowledged the existence of the integral part doctrine in - 76 -

providing an exception to the feeder organization rules under

section 502.23

Section 1.502-1(b), Income Tax Regs., provides as follows:

(b) If a subsidiary organization of a tax-exempt organization would itself be exempt on the ground that its activities are an integral part of the exempt activities of the parent organization, its exemption will not be lost because, as a matter of accounting between the two organizations, the subsidiary derives a profit from its dealings with its parent organization, for example, a subsidiary organization which is operated for the sole purpose of furnishing electric power used by its parent organization, a tax-exempt educational organization, in carrying on its educational activities. However, the subsidiary organization is not exempt from tax if it is operated for the primary purpose of carrying on a trade or business which would be an unrelated trade or business (that is, unrelated to exempt activities) if regularly carried on by the parent organization. For example, if a subsidiary organization is operated primarily for the purpose of furnishing electric power to consumers other than its parent organization (and the parent’s tax-exempt subsidiary organizations), it is not exempt since such business would be an unrelated trade or business if regularly carried on by the parent organization. Similarly, if the organization is owned by several unrelated exempt organizations, and is operated for the purpose of furnishing electric power to each of them, it is not exempt since such business would be an unrelated trade or business if regularly carried on by any one of the tax-exempt organizations. For purposes of this paragraph, organizations are related only if they consist of--

(1) A parent organization and one or more of its subsidiary organizations; or

23 Although these regulations relate expressly to determining whether an organization is a feeder organization within the meaning of sec. 502 (an issue that respondent does not raise in the instant case), this Court previously has referred to these regulations in applying the integral part doctrine in the context of sec. 501(c)(3) exemptions. See Geisinger Health Plan v. Commissioner, 100 T.C. 394, 401 (1993), affd. 30 F.3d 494 (3d Cir. 1994). - 77 -

(2) Subsidiary organizations having a common parent organization. An exempt organization is not related to another exempt organization merely because they both engage in the same type of exempt activities.

Since Squire, only a relatively small number of cases have

applied the integral part doctrine. These cases are fact-

specific. See Geisinger Health Plan v. Commissioner, 30 F.3d

494, 501 (3d Cir. 1994), affg. 100 T.C. 394 (1993), and cases

cited therein. As applied in a number of these cases, the

integral part doctrine requires the organization in question to

provide “necessary and indispensable” services solely to an

exempt organization to which it bears some legal or significant

operational relationship. See, e.g., Hospital Bureau of

Standards & Supplies, Inc. v. United States, 141 Ct. Cl. 91, 158

F. Supp. 560, 562 (1958) (recognizing exemption of an

organization that provided “necessary and indispensable” product

testing and purchasing of hospital supplies for its exempt member

hospital); University Med. Resident Servs., P.C. v. Commissioner,

T.C. Memo. 1996-251 (membership organizations that conducted

clinical training programs for member universities were not

exempt); Council for Bibliographic & Info. Techs. v.

Commissioner, T.C. Memo. 1992-364 (recognizing exemption of an

organization that conducted “necessary and indispensable”

activities for exempt member libraries). As applied in these

cases, the integral part doctrine operates to recognize a - 78 -

derivative exemption of an organization which serves only another

exempt organization and performs essential services that the

client organization otherwise would have performed for itself to

accomplish its own exempt purposes. See B.S.W. Group, Inc. v.

Commissioner, 70 T.C. 352, 360 (1978); University Med. Resident

Servs., P.C. v. Commissioner, supra, and cases cited therein.

Consistent with this rationale, professional group practices

serving exempt entities have been granted tax exemption under the

integral part doctrine. See University of Mass. Med. Sch. Group

Practice v. Commissioner, 74 T.C. 1299 (1980); B.H.W. Anesthesia

Found., Inc. v. Commissioner, 72 T.C. 681 (1979); University of

Md. Physicians, P.A. v. Commissioner, T.C. Memo. 1981-23. These

cases involved anesthesiology services or faculty medical

activities that were provided solely to the served hospital or

medical school and that were essential to the operation of the

hospital or medical school. See Geisinger Health Plan v.

Commissioner, 100 T.C. 394 (1993).

In Geisinger Health Plan v. Commissioner, supra, this Court

denied a claim for tax exemption asserted by an HMO under the

integral part theory. We reasoned that the group-practice line

of cases was not controlling because, unlike the exempt

organizations in those cases, the HMO had a population of

subscribers that did not overlap substantially with the patients

of the related exempt entities. In considering whether the HMO’S - 79 -

activities would have constituted an unrelated business if

conducted by its affiliate, we noted that section 513(a) defines

“unrelated trade or business” by reference to conduct that is

“not substantially related” to the organization’s exempt

functions. We stated that the determination whether conduct is

“substantially related” in this context “considers the degree to

which income is earned from services rendered or sales made to

persons who are not patients of the exempt affiliated entity.”

Id. at 405. Noting that entities related to the HMO provided 80

percent of the hospital services rendered to the HMO’s patients,

we held that the record in Geisinger did not justify a conclusion

as to whether the instances in which the HMO’s subscribers were

served by unrelated entities were substantial or insubstantial.

See id. at 406. Accordingly, we held that the HMO failed to

establish that its activities comprised an integral part of its

affiliate’s exempt activities.

Similarly, in the instant case, petitioner has failed to

establish that the Surgery Center’s patient population overlaps

substantially with that of Redlands Hospital. The record does

not reveal what percentage of persons served at the Surgery

Center are patients of Redlands Hospital. Clearly, however, the

Surgery Center was performing ambulatory surgery on a for-profit

basis for its own patients before petitioner was ever involved

and presumably continued to do so afterward. - 80 -

Even if we were to assume, arguendo, that the patient

populations of the Surgery Center and Redlands Hospital overlap

substantially, this circumstance would not suffice to confer

exemption on petitioner under the integral part doctrine. In all

the precedents cited above in which courts have applied the

integral part doctrine to recognize a derivative exemption, the

organization has been under the supervision or control of the

exempt affiliate (or a group of exempt affiliates with common

exempt purposes) or otherwise expressly limited in its purposes

to advancing the interests of the affiliated exempt entity or

entities, and serving no private interests.24 For instance, in

Squire v. Student Book Corp., 191 F.2d 1018, 1019 (9th Cir.

1951), all actions of the bookstore's board of trustees were

submitted to the president of the college for approval, and the

college comptroller acted as ex officio treasurer of the

bookstore. The bookstore paid no rebates and no part of its

earnings inured to private benefit. It seems clear that such

considerations are central to the court's holding in Squire that

24 In Geisinger Health Plan v. Commissioner, 100 T.C. 394, 402 (1993), affd. 30 F.3d 494 (3d Cir. 1994), we stated that the parties had agreed that “an organization is entitled to exemption as an integral part of a tax-exempt affiliate if its activities are carried out under the supervision or control of an exempt organization and could be carried out by the exempt organization without constituting an unrelated trade or business” (emphasis added). In Geisinger, we made a factual finding that the affiliated exempt foundation controlled the HMO. See id. at 396. - 81 -

the bookstore's business enterprise “bears a close and intimate

relationship to the functioning of the College itself.”25

By contrast, as previously discussed, petitioner's sole

activity (the Surgery Center) is effectively controlled by for-

profit parties. The operations of the Surgery Center plainly are

not dedicated to advancing the interests of petitioner’s exempt

affiliates other than as those interests might happen to coincide

with the commercial interests of petitioner’s for-profit

25 See also University of Mass. Med. Sch. Group Practice v. Commissioner, 74 T.C. 1299 (1980) (organization granted exemption was created pursuant to a special act of the State legislature as an integral part of the affiliated medical school and university hospital); B.H.W. Anesthesia Found., Inc. v. Commissioner, 72 T.C. 681, 683 (1979) (organization granted exemption was the incorporation of the affiliated hospital's department of anesthesiology, and most control rested directly or indirectly with the department's chairman); Brundage v. Commissioner, 54 T.C. 1468 (1970) (public museum that was determined to be an integral part of the City of San Francisco’s city school system had previously been conveyed to the city); Estate of Thayer v. Commissioner, 24 T.C. 384 (1955) (alumni association’s activities were for the purpose of advancing the affiliated public university, which held possession of, administered, and invested the association’s endowment fund, with no moneys used for the benefit of any alumnus); University Med. Resident Servs., P.C. v. Commissioner, T.C. Memo. 1996-251 (organizations’ memberships consisted entirely of nonprofit schools and affiliated teaching hospitals, representatives of which made all decisions about the organizations’ activities); Council for Bibliographic & Info. Techs. v. Commissioner, T.C. Memo. 1992-364 (organization’s membership consisted entirely of public and academic libraries, representatives of which comprised the organization’s board of trustees); University of Md. Physicians, P.A. v. Commissioner, T.C. Memo. 1981-23 (the organization's articles limited its activities to serving the interests of the affiliated medical school and hospital, and petitioner could not be used to serve any private purpose of its stockholders); Hospital Bureau of Standards & Supplies, Inc. v. United States, 141 Ct. Cl. 91, 158 F. Supp. 560, 562 (1958) (organization’s membership consisted entirely of nonprofit hospitals). - 82 -

partners. Moreover, as previously discussed, petitioner

impermissibly serves private interests. Petitioner’s activity is

not so substantially and closely related to the exempt purposes

of its affiliates that these private interests may be

disregarded. See Geisinger Health Plan v. Commissioner, 100 T.C.

at 406, 407. Accordingly, petitioner is not entitled to

exemption under the integral part doctrine.

Remaining contentions not addressed herein we deem

irrelevant, without merit, or unnecessary to reach.

To reflect the foregoing,

Decision will be entered

for respondent. - 83 -