To avoid tax issues, U. signs one-year outsourcing deal

A newly restructured contract to outsource facilities management to Trammell Crow Co. may allow Penn to take advantage of a tax-law loophole. But the deal will also leave the University empty-handed for the time being. Executive Vice President John Fry signed the revised agreement Wednesday. The deal includes a one-year preliminary term with a stipulation for a second, nine-year term in order to comply with federal income-tax restrictions. Furthermore, although Dallas-based Trammell Crow initially agreed to pay the University $26 million up front for helping to start its Trammell Crow Higher Education Services unit, officials are now opting to defer payment until after the Internal Revenue Service issues its stamp of approval on the deal, according to Vice President for Facilities Services and Contract Management Omar Blaik. He added that since the original non-binding letter of intent -- signed October 8 -- was for a 10-year term, both parties agreed that the University will be entitled to payment once the nine-year extension is secured. Penn will still pay Trammell Crow $5.25 million per year to manage about 10 million square feet of its building space. For the past several months, the University has been tweaking the deal in order to preserve the tax-exempt status of campus buildings that will be managed by the company. By instituting a preliminary agreement and extension, the University will try to avoid a potential violation of an IRS regulation announced last year. Under the IRS' new set of "management contract" restrictions, joint ventures between non-profit and for-profit corporations could jeopardize a non-profit's tax-exempt status. In accordance with the regulations, all buildings managed by Trammell Crow and financed with tax-exempt debt could be declared taxable. This prospect is especially detrimental to Penn's bondholders whose bonds finance University buildings, University Vice President for Finance Kathy Engebretson said. She added that these bondholders would receive a "bad return" on their investments if the buildings are taxed. According to Blaik, the deal will be submitted to the IRS in a few weeks and the agency will hand down a ruling within the next four months. Although Blaik said an unfavorable ruling is "very unlikely," he stressed the need for the University to "play it safe." Categorizing the unprecedented deal between the University and Trammell Crow as an "uncharted area," Blaik noted that if the IRS does not approve the initial deal, the University will try to qualify for a "safe harbor" exemption, which is a loophole that applies to companies that do not quite fit into the type of arrangement the new law covers. In order to qualify for this exemption, Penn may change the length of the contract or the nature of the payment. Penn can alter the payment by replacing variable payments -- or payments made if certain conditions are fulfilled -- with fixed payments, or payments minus conditions. Blaik noted that definitions are often subject to the interpretation of the individual auditor. "The whole thing is technical," Blaik said, adding that the regulations merely involve an adjustment to the"packaging" of the deal. He also characterized the IRS restrictions as not "applicable" to the situation at hand, given that University facilities are used for "research and education" purposes. "The fact that Trammell cleans a building doesn't mean that it's Trammell headquarters," he said. No matter which way the IRS leans, Board of Trustees Chairperson Roy Vagelos insisted yesterday that the first year of the deal will not endanger the University's tax-exempt status. And Blaik said Penn will immediately begin to implement the one-year contract to assure employees a relatively smooth transition period. Regardless of the outcome of the IRS review, Fry stressed that the University will not cease negotiations with Trammell Crow.