Opinion ID: 450362
Heading Depth: 2
Heading Rank: 2

Heading: Proprietary Costs

Text: 8 Proprietary costs are those expenses incurred solely as a result of a hospital's for-profit status. These include the costs associated with attracting private investment capital. The specific proprietary costs at issue here are stock maintenance costs, income taxes, the inclusion of tax liability in calculating equity capital and the rate of return on equity capital. Humana seeks an amount of reimbursement for proprietary costs limited to a level sufficient to recoup its 'costs,'  including the expenses of attracting investment capital. 17 It argues that all other government programs, except Medicare, allow for reimbursement of all of these costs. 18 9 The Secretary contends that these proprietary costs are not costs of patient care as allowed under 42 U.S.C. Sec. 1395x(v)(1)(A). 19 The costs are, in addition, not necessary in the efficient delivery of needed health services as required by 42 C.F.R. Sec. 405.451(a) (1983). The Secretary also maintains that Congress has included recognition of proprietary costs in the allowable rate of return on equity capital, which is based on one and a half times the interest on debt obligations issued by the Federal Hospital Insurance Trust Fund (FHITF). 20 Therefore, in the Secretary's view, no reimbursement for proprietary costs was intended under 42 U.S.C. Sec. 1395x(v)(1)(A), the reasonable costs provision of the Act.
10 Stock maintenance costs include Security and Exchange Commission (SEC) filing fees, stock transfer fees, and the costs of shareholder meetings and reports. 21 Humana contends that these expenses are no different in substance than either incorporation fees or other corporate expenses, which are reimbursed under the Program, or the transaction costs associated with attracting debt financing, which are similarly reimbursed. 22 It cautions that the Secretary's disallowance of reimbursement for these expenses will result in cross-subsidization, the shifting of Medicare costs to non-Medicare patients, which is prohibited under the Act. 23 11 The guiding precedent in this circuit is American Medical International, Inc., v. Secretary of Health, Education and Welfare (AMI). 24 In AMI, the provider hospitals challenged the Secretary's denial of reimbursement for various expenses, including stock maintenance costs. The district court drew, and we affirmed, the distinction between reimbursable and nonreimbursable costs based on the purpose they served: 12 A crucial distinction must be drawn between costs which are necessary for the maintenance of a corporate structure and those which are necessary for providing medical services. Stock maintenance costs are necessary for a corporation to exist, but medical services can be provided without the corporate form. 25 13 Today we reaffirm this distinction. The purpose of the Medicare reimbursement scheme is to refund the cost of providing medical services. These services can be provided in a variety of settings, both proprietary and nonprofit. It is the Secretary's task to ferret out those costs incurred by proprietary hospitals which actually relate to medical care. 14 The regulations implementing the Act allow reimbursement for both direct and indirect costs. 26 At some point, however, certain indirect costs become too attenuated to be regarded as for the provision of medical services. To make these distinctions, the Secretary employs the primary purpose test, 27 determining the primary purpose of a given activity and its associated cost. 15 In the case of stock maintenance costs, submitting SEC filings, paying stock transfer fees, and conducting and reporting on shareholder meetings all serve to protect the shareholders and to enhance their investment. 28 While the indirect effect of stock maintenance activities may sometimes benefit medical services, the connection is too indirect. The Act gives no preference to one particular organizational structure. It should not, therefore, subsidize the continuing costs of a provider's choice of corporate structure. 16 Humana disputes the distinction between stock maintenance costs and incorporation fees and the transaction costs of attracting debt financing. 29 Again, we find the Secretary has rationally exercised her line-drawing authority. The Act is structured to encourage the creation of medical facilities. Incorporation and the securing of adequate debt financing bring such facilities into existence. Reimbursement for these expenses is consistent with the intent of the Act. Once a facility is in existence and medical services are being rendered, however, stock maintenance costs inure primarily to the benefit of shareholders, not patients. 17 We find Humana's contention that disallowance of stock maintenance costs will result in illegal cost-shifting to non-Medicare patients to be without merit. The prohibition against cross-subsidization applies solely to costs relating to patient care. Since we have determined that stock maintenance costs relate to maintenance of the corporate entity as opposed to the reasonable cost of providing medical care, no cost-shifting has occurred. The Secretary's basis of distinguishing between the costs of patient care and other nonreimbursable costs is both logical and rational. 30
18 Humana claims to be entitled to reimbursement for the funds expended in satisfying its federal and state income tax liability. It argues that income taxes are a cost of doing business for investor-owned facilities and are always reimbursed by other government programs. 31 In addition, Humana contends that the income tax liability, if not reimbursed, will be passed on to non-Medicare patients, resulting in prohibited cross-subsidization. 32 19 The Secretary contends that income taxes do not act to increase the cost of providing medical care, only to decrease proprietary facilities' profits. 33 We affirm the Secretary's determination. Income taxes, like any other claimed expense, must be evaluated under the reasonable cost standard of 42 U.S.C. Sec. 1395x(v)(1)(A) (1982). Reasonable costs include only those expenses incurred in the efficient delivery of needed health services. The very concept of income taxes, a tax on earned profits, refutes Humana's claim for reimbursement. Relying on the AMI court's approach of looking at the purpose of a given expense, we conclude that income tax liability is not a necessary cost of rendering medical care. 34 20 As discussed earlier, medical services are provided in both proprietary and in nonprofit facilities. Liability for income taxes comes about only when a proprietary hospital earns a profit. The cost is associated with enhancing the shareholders' investment, not with the provision of medical care. 35 Humana claims that to disallow income tax reimbursement is to differentiate unfairly between proprietary and nonprofit hospitals. The statute and its implementing regulations, however, do not require that all hospitals be treated identically, only equitably. 36 Moreover, the allowance of income tax reimbursement could result in extremely disparate treatment among proprietary facilities themselves. The amount of tax owed can depend on a variety of factors, including financial structure, carryover of past losses, or corporate organization. Two hospitals may offer the same medical services and charge the same fees, yet have vastly different tax liabilities. 21 The fact that certain other governmental programs provide reimbursement for income tax expenses is not an adequate rationale for providing them under Medicare. Humana's argument focuses on public utility case law, an area not analogous to Medicare reimbursement. First, a hospital's decision to enter into a contract with Medicare is voluntary. Hospitals are in no way compelled to participate in the program. In contrast, public utilities are forced to operate within a tightly regulated scheme if they are to operate at all. Second, public utilities are strictly prohibited from setting rates that recoup past losses. 37 Unlike ratemaking in the utility industry, Medicare reimbursements have until recently--and at all times relevant to this litigation--been entirely retrospective and based on actual costs. 22 We find Humana's contention that denial of reimbursement for income taxes results in cross-subsidization to be without merit. The subsidization prohibited by regulation 38 refers to the shifting of the costs of providing medical services between Medicare and non-Medicare patients. Since income taxes do not fall into this reasonable cost category, no cross-subsidization has occurred. Whether income taxes are a cost of doing business for proprietary hospitals and whether they are a cost of providing medical services are two wholly distinct issues. We refuse to take the quantum leap required by Humana's argument of equating the two. 23 Humana asserts that if income taxes are not reimbursed as part of reasonable costs, the same tax liabilities must not be included in the calculation of equity capital. 39 Humana would then be entitled to a return on equity capital for the funds used to pay income taxes. The Secretary responds that only net working capital actually available for patient care may properly be included in the calculation of each provider's equity capital. 40 We affirm. Equity capital includes 24 (1) the provider's investment in plant, property, and equipment related to patient care ... and 25 (ii) Net working capital maintained for necessary and proper operation of patient care activities.... 41 26 Under 42 C.F.R. Sec. 405.429(a) (1983), return on equity capital, based on one and one-half times the interest on debt obligations issued by the Federal Hospital Insurance Trust Fund (FHITF), is allotted for proprietary providers. In order to calculate the net working capital component of equity capital, the provider's current liabilities are subtracted from its current assets. The sole question here is whether income tax liability must also be subtracted from net working capital. 27 This question was fully addressed in AMI. Explaining why the hospitals' argument against inclusion of income tax liability was inapposite 42 the district court stated: 28 This approach misses the mark. These regulations do clearly establish that a return on equity capital is only allowed on that portion of equity capital related to patient care. Therefore, liabilities not related to patient care (such as ... taxes based on net income) must be subtracted from working capital to arrive at the net working capital necessary and proper for patient care services. This is accomplished by including the ... tax liability in the return on equity capital computation. 43 29 Income taxes must be subtracted from the hospitals' current assets to arrive at the actual net working capital invested in patient care. 44