Does a revenue-sharing agreement between a hospital district and its radiologists create a separate entity subject to Texas franchise (margin) tax?

Plain-English summary

A hospital district asked the Texas Comptroller whether its long-running revenue-sharing arrangement with a group of radiologists creates a separate entity subject to Texas franchise tax. The arrangement (renewed in 2016, following an earlier 2003 version) split net revenue from six imaging centers 75%/25% between the district and the radiologists, was jointly managed by a board with equal representation from both sides, and required both sides to help fund new equipment purchases in proportion to their ownership interests. Notably, the agreement's own text said the parties did not intend to create "a partnership, joint venture or association" — while also acknowledging, for federal tax purposes only, that the arrangement met the federal definition of a partnership and required filing a federal partnership tax return.

The Comptroller ruled yes, this is a taxable joint venture. Texas franchise tax's list of "taxable entities" includes a "joint venture," which the Comptroller's own rule defines as a partnership engaged in the joint prosecution of a particular transaction for mutual profit. The Comptroller found the district and radiologists were jointly pursuing providing radiology treatment services for mutual profit — pointing to the shared revenue formula, the equal-representation management board with real decision-making authority (including over budgets and equipment purchases), and the radiologists' proportional funding obligation for equipment. The contract's stated intent not to form a joint venture didn't control, because the parties' actual conduct and financial arrangement matched the legal definition. The Comptroller also rejected the district's argument that "particular transaction" requires something narrower than an ongoing, multi-year radiology services arrangement, and found the statutory carve-out for co-ownership arrangements that elect out of federal partnership treatment didn't apply, since the parties never made that election — in fact, they affirmatively filed a federal partnership return.

What this means for you

Hospital districts and other governmental entities with revenue-sharing physician arrangements

Contract language disclaiming partnership or joint-venture status will not, by itself, prevent Texas from treating a revenue-sharing arrangement as a taxable joint venture. What matters is the substance: shared profit, joint management authority, and shared risk/funding obligations. If your arrangement has those features, expect Texas to look past a "this is not a partnership" clause.

Physician groups and other professionals in revenue-sharing arrangements with institutions

If you and an institutional partner (hospital, university, government entity) jointly manage a service line, split net revenue, and share funding obligations for shared equipment or infrastructure, the combined arrangement itself may be a separate Texas franchise tax filer — distinct from your own professional practice's filing obligations.

Accountants and tax professionals

Key hooks: 34 Tex. Admin. Code Rule 3.581(b)(10)'s definition of "joint venture" (partnership engaged in joint prosecution of a particular transaction for mutual profit), and Section 171.0002(a)'s narrow carve-out for co-ownership arrangements that formally elect out of federal partnership treatment under IRC § 761(a) — an election these parties never made (indeed, they did the opposite by filing a federal partnership return). The ruling also cites STAR Accession No. 201712002L as prior guidance on when a joint development agreement creates a taxable joint venture.

Common questions

Q: If a contract says the parties don't intend to form a joint venture, does that control for Texas franchise tax purposes?
A: No. This ruling found the parties' actual conduct and financial arrangement — shared profit, joint management, shared funding — created a joint venture regardless of the contract's stated intent otherwise.

Q: Does treating indigent-patient costs differently, or including tax revenue in the district's funding, disqualify an arrangement from being a "mutual profit" joint venture?
A: No — the ruling found neither factor disqualified the arrangement from operating for mutual profit.

Q: How can parties avoid joint-venture treatment for a co-ownership or cost-sharing arrangement?
A: By meeting the requirements to elect out of federal partnership treatment under IRC § 761(a) and Treas. Reg. § 1.761-2(a)(3) — the statutory carve-out in Section 171.0002(a). These parties did not make that election, and in fact filed a federal partnership return, cutting against them.

Q: Can another hospital district or physician group rely on this ruling directly?
A: Not automatically. A private letter ruling binds the Comptroller only for the taxpayer and facts in the request. A similar-looking arrangement with different management, funding, or revenue-sharing terms could come out differently.

Citations and references

Statutes and rules:

• Tex. Tax Code § 171.001 (Tax Imposed)
• Tex. Tax Code § 171.0002 (Definition of a Taxable Entity)
• Tex. Tax Code § 171.0002(a) (carve-out for co-ownership arrangements electing out of federal partnership treatment)
• 26 U.S.C. § 761, § 761(a) (federal partnership definition and election-out provision)
• Treas. Reg. § 1.761-2(a)(3) (election-out requirements)
• 34 Tex. Admin. Code Rule 3.581(b)(10) (Margin: Taxable and Nontaxable Entities — "joint venture" defined)
• Special District Local Laws Code § 1061.101 (District Responsibility)

Cited prior guidance:

• STAR Accession No. 201712002L — guidance on whether a joint development agreement creates a taxable joint venture

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=MAR
• Opinion: https://star.comptroller.texas.gov/view/202106021L

Original ruling text

Date: June 21, 2021

RE: Private Letter Ruling No. PLR20200409083336

Dear **:

We issue this private letter ruling in accordance with Rule 3.1, Private Letter Rulings and General Information Letters. [ENDNOTE 1] We are responding to your request dated April 8, 2020 and supplemental information provided on May 18, 2020 and April 15, 2021. Detrimental reliance relief is provided in accordance with Rule 3.10, Taxpayer Bill of Rights.

You requested guidance regarding whether a revenue sharing agreement entered into between ** (district) and several of its radiologists (radiologists; collectively the parties) created an entity that is subject to the Texas Franchise Tax.

Facts Presented

The relevant facts are based on the following documents provided for review by **:

• the initial private letter ruling request dated Apr. 8, 2020;

• the amended and restated Net Revenue Agreement entered into between the parties on Aug. 1, 2016 (agreement), including its attached exhibits [ENDNOTE 2]; and

• the May 18, 2020 email response to the request for information from Tax Policy sent on May 1, 2020. This email response also included these documents:

o a contract between COMPANY A and COMPANY B dated Feb. 1, 2016;

o the prior iteration of the net revenue agreement between the parties, dated Oct. 1, 2003 (prior agreement); and

o a financial statement from Nov. 2019 (financial statement) showing the allocation of costs for the purchase of equipment and the net revenue payout provided to the radiologists.

• the Apr. 15, 2021 email response to the request for information from Tax Policy sent on Mar. 29, 2021 (second response).

The district is a political subdivision of the State of Texas. The district has “full responsibility for providing hospital care for the district's indigent residents.” Special District Local Laws Code § 1061.101 (District Responsibility). The district provides the radiology services relevant to this ruling at six imaging centers (sometimes referred to as the DIA entities or DIA) staffed, in part, by the radiologists.

The parties entered into the prior agreement in Oct. of 2003 and renewed that agreement with the amended and restated Net Revenue Agreement of Aug. 2016. Although there are some differences between the two, they are largely the same. The parties outline that the intent of the agreements was not “creating a partnership, joint venture or association, nor to render the Parties jointly or collectively liable under any circumstances.” Agreement § 11 & 12. Notwithstanding this language, the parties also “recognize that the definition of a partnership for federal income tax purposes, pursuant to Section 761 (Terms Defined), and the Regulations thereto, of the Internal Revenue Code of 1986, as amended, includes business ventures such as that being undertaken by the Parties. Therefore, the Parties agree, exclusively for federal income tax purposes, that a Federal Partnership Income Tax Return shall be filed…The filing of tax returns shall not be interpreted as affecting or altering the intention of the Parties hereto as to the nonexistence of partnership status for all other purposes.” Agreement § 12.

The district receives 75 percent and the radiologists receive 25 percent of the net revenue for certain services provided at the imaging centers. The 25 percent allocated to the radiologists is further allocated between the radiologists based upon their individual ownership percentage. The determination of net revenue follows a formula prescribed by the agreement and includes only certain revenues and expenses. Exhibit A § 1-3. Calculation of net revenue and payment in the event of positive net revenue occurs on a monthly basis and is referred to as an “advance.” The radiologists are not required to make contributions in the event of negative net revenue, but any negative net revenue is carried forward against future advances. Agreement § 4. Net revenues are distributed to the parties “only to the extent there is cash theretofore generated in the operation of DIA that is not reasonably required to provide operating funds for DIA.” Id.

Additionally, there is a requirement for an annual accounting of net revenue. Agreement § 2(a). If the annual accounting reveals a greater net revenue than what was determined when calculating advances, the radiologists receive an additional payment to cover the difference. If the annual accounting reveals a smaller net revenue than what was determined when calculating advances, the district can issue an invoice to the radiologists to recover the difference or subtract that amount from future advances. Id. The district is required to keep records of “the costs and expenses incurred, and charges made and all receipts and credits received with respect to DIA” and keep these records available for examination and inspection by the radiologists. Agreement § 3(a).

The imaging centers are managed by the district and a management board (board) created by the agreement. Recital F; Agreement § 6; Exhibit A § 10 & 11. The board consists of 2 or more radiologists and an equal number of individuals selected by the district. Exhibit A § 10. The agreement outlines that this structure was selected so that the parties “shall have equal voting power on the management board.” Id. The board is required to make recommendations to the district and the radiologists “regarding the management and conduct of the operations of DIA, including but not limited to the preparation of an annual budget therefor.” Id. At least one radiologist board member and one board member representing the district must be present for a quorum, and an affirmative vote of a majority of the present members is necessary for any action by the board. Exhibit A § 11(b) and (c). The number of employees used by the imaging centers in conducting operations, the selection of employees, and hours of labor and compensation for services performed are determined by the district after reasonable consideration of input from the board. Exhibit A § 7. All non-party employees are employees of the district.

All equipment used by the parties in providing radiology services is owned solely by the district. Recital E. Despite ownership of the equipment being held entirely by the district, when the initial equipment was purchased for the 2003 iteration of the agreement the costs were split between the district and the radiologists subject to the prior agreement. Prior Agreement – Recitals. The ownership percentages assigned to the district and the radiologists provided a proportionate percentage of net revenue, which differs slightly from the current agreement.

When the district desires to purchase new or replacement equipment it must draft a “new proposal” that provides “written notice of the proposed new equipment, specifying the proposed location, space and personnel required, and the estimated costs of acquisition and installation of the new equipment.” Agreement § 9(a). The district is then required to “consider and incorporate” feedback received by the board. Id. A purchase of equipment exceeding $250,000 requires approval by the board of directors of the district and a purchase exceeding $1,000,000 additionally requires approval by a majority of the management board. Agreement § 9(a) and (d). All acquisition and installation costs are borne by the parties in the percentage of their interests outlined in Exhibit B. Agreement § 9(c); See also financial statement. Radiologists are not required to contribute capital for the purchase of such equipment, but the assigned proportion of the cost is held against future distributions of net revenue. Financial statement.

If there is a negative net revenue for multiple consecutive months, and certain other conditions are met, the district can discontinue the agreement. Agreement § 16(c). If the district discontinues the agreement it is required to give written notice to the radiologists. This notice must also specify the district’s estimates of the fair market value of the equipment, fixtures and other hard assets, the cost and expense of which was paid by the district and the radiologists for the benefit of the imaging centers, and contain an offer to purchase these items for the fair market value specified in the notice. Id.

Taxes formed approximately 10 percent of the district’s revenue in 2018. [ENDNOTE 3] For the period of Oct. 2018 through Sept. 2019, 12.2 percent of the district hospital’s “gross charges” are from indigent patients, which are categorized as “bad debts” for accounting purposes. Second response. Radiologists are not compensated for the treatment of indigent patients:

“The radiologists benefit from two buckets of revenue generated by the radiology services. One, the revenue generated from the technical work and billed by the hospital. The radiologists share in the reimbursement associated with these services. Second, the radiologists will bill all patients, including indigent and unfunded, for their professional services. These revenues are separate from the Net Revenue Agreement and are billed and collected under the radiology group. The hospital district does not share in these revenues.”

Question, Ruling, and Analysis

Our restatement of your question is shown below, followed by our response and analysis.

Question:

Does the revenue sharing agreement entered into by the parties create an entity that is subject to the Texas Franchise Tax?

Ruling:

Yes. The revenue sharing agreement entered into between the district and the radiologists creates an entity that is subject to the Texas Franchise Tax.

Analysis:

The franchise tax applies to each taxable entity doing business in Texas or organized in Texas. Section 171.001 (Tax Imposed). Section 171.0002 (Definition of a Taxable Entity) identifies all entities that are considered “taxable entities” and includes, in relevant part, a partnership, joint venture or “other legal entity.”

STAR 201712002L provides guidance as to whether a joint development agreement creates a joint venture subject to the Franchise Tax. The term joint venture is not defined within Chapter 171 of the Texas Tax Code. Rule 3.581(b)(10) (Margin: Taxable and Nontaxable Entities), defines “joint venture” to mean a “partnership engaged in the joint prosecution of a particular transaction for mutual profit.”

Section 171.0002(a) provides additional guidance as to what will not be considered a joint venture for franchise tax purposes:

“A joint venture does not include joint operating or co-ownership arrangements meeting the requirements of Treasury Regulation Section 1.761-2(a)(3) that elect out of federal partnership treatment as provided by Section 761(a), Internal Revenue Code.”

Under the terms of the agreement, the parties are engaged in the joint prosecution of a particular transaction – providing radiology treatment and related services – for mutual profit. The district’s arguments that they are not engaged in a particular transaction are unpersuasive. The authorities cited by the parties do not establish that a particular transaction must be limited to a single transaction and explicitly state that a particular enterprise fits within the category of a joint venture. Additionally, providing radiology services is sufficiently narrow within the scope of medical services provided by the district to constitute a particular transaction. The agreement therefore creates a joint venture under Rule 3.581(b)(10). The inclusion of taxes as a portion of the district’s revenue and the treatment of indigent patients by the parties do not disqualify the parties from operating for mutual profit. Further, the parties did not elect out of federal partnership treatment, as provided by Internal Revenue Code, Section 761(a), so the parties do not meet the exclusion set out in Section 171.0002(a).

STAR documents cited can be found on the Comptroller’s State Tax Automated Research (STAR) system. The Texas Tax Code, Texas Administrative Code, and the STAR system are accessible at www.comptroller.texas.gov/taxes/.

If you have questions about this private letter ruling, please email us through our website at https://comptroller.texas.gov/web-forms/tax-help/ and reference Private Letter Ruling No. 20200409083336.

Sincerely,

Tax Policy Division – Direct Taxes

Texas Comptroller of Public Accounts

ENDNOTES

1 Unless otherwise indicated, all references to “Section” are to the Texas Tax Code, and all references to “Rule” are to Title 34 of the Texas Administrative Code.

2 Any reference to an exhibit is to the exhibits included with the amended and restated Net Revenue Agreement entered into between the parties on August 1, 2016. Any reference to recitals is to the recitals within that same document.

3 ** District – Independent Auditor’s Report and Financial Statements, September 30, 2018 and 2017. Accessed on 5/22/21, page 8, at ** district website.