Appeals Court Reverses Tax-Exemption Ruling

By Elizabeth Schwinn

A federal appeals court has ruled that, to retain its tax exemption, a charity hospital must do more to demonstrate that it retains control of a joint venture with a for-profit partner.

The decision by the U.S. Court of Appeals for the Fifth Circuit overturns a lower court’s ruling that the hospital, St. David’s Health Care System, in Austin, Tex., had sufficiently shown it controlled the venture. The appeals court also nullified the lower court’s order that the Internal Revenue Service must restore the hospital’s tax exemption and pay the hospital’s lawyers’ fees.

At issue in the case — which involved St. David’s and its for-profit partner, Columbia/HCA Healthcare Corporation — was whether the charity had the authority to guarantee that it would engage only in activities that furthered its charitable purpose and whether HCA could impose its will on the hospital. Among other problems, half of the directors on St. David’s governing board were appointed by HCA, the court noted. It remanded the case to a lower court to examine whether St. David’s meets certain “control tests” that will determine whether the charity has ceded control to its for-profit partner.

The ruling contradicts a decision last year by the U.S. District Court for the Western District of Texas, which found that the hospital was entitled to retain its tax exemption because of “extraordinary protections” against the hospital’s being operated to benefit a private company, including the fact that the chairman of the board was appointed by St. David’s (The Chronicle, June 27, 2002).

But the Fifth Circuit court said that a subsidiary of HCA, not the governing board, made day-to-day decisions, and said that despite assertions by St. David’s that it has power over the chief executive of the partnership, it had not taken punitive action against him for failing to prepare required annual reports on the amount of charity care provided by the hospital.

The case is St. David’s Health Care System v. United States of America, No. 02-50959.