Opinion ID: 429783
Heading Depth: 2
Heading Rank: 4

Heading: Capitalization of Return on Equity in Aircraft.

Text: 91 The final issue we must contend with requires us to draw a distinction between reimbursement for necessary and proper costs of patient care and payment of a return on equity capital invested in hospital facilities. During 1973 HCA owned three aircraft which it used for current hospital operations, construction of new hospitals, and carrying out its acquisition activities. The issue here is whether, to the extent the aircraft were used for construction and acquisition activities, a return on equity may be capitalized and added to the historical cost of the new facilities constructed. 92 The plaintiffs' contentions can best be explained through the use of an example: Suppose that HCA had invested $100,000 in an airplane with a useful life of 10 years and that it used the airplane for current hospital operations 75% of the time, and for hospital construction activities 25% of the time. Assume further that the airplane is in its third year of operation, that the return on equity paid by Medicare that year is 10%, and that the airplane is depreciated on a straightline basis. 93 Medicare would allow $7,500 ($100,000 X 75% X 1/10) 36 in depreciation for that portion of the aircraft used for current operations. Moreover, for that part of the aircraft used in construction activities, HCA would be allowed to capitalize depreciation of $2,500 ($100,000 X 25% X 1/10) and add this amount to the historical cost of the completed facilities to be reimbursed over a gradual basis. 94 HCA would also be paid a return on net equity for that portion of the aircraft used for current operations. HCA's net equity in the aircraft by the third year would be $80,000 ($100,000 original investment minus two years depreciation of $20,000--$7,500 per year attributed to current operations, and $2,500 per year attributed to construction operations). Thus, HCA's return would equal $6,000 ($80,000 [net equity] X 10% [rate of return] X 75% [time used for current operations]. 95 At issue here is whether HCA should be allowed to compute a return on equity for that portion of the aircraft used in construction activities, and then add that amount to the historical cost of the completed facilities. If so, then HCA would be allowed to capitalize a current return on equity of $2,000 ($80,000 [net equity] X 10% [rate of return] X 25% [time used for construction activities]. 96 HCA's fiscal intermediaries would not allow such a return, whether capitalized or not. The plaintiffs argue, however, that the applicable Medicare statute and regulations authorize HCA to capitalize a return on equity in the aircraft during the time it was used for construction. They note that the historical cost of a facility (upon which a return on equity capital is based) is defined in 42 C.F.R. Sec. 405.415(b) as the cost incurred in acquiring the asset. (Emphasis added.) Because, they contend, a return on equity capital is a reasonable cost under Medicare, this cost must be added to the historical cost of the buildings under construction. The Secretary contends, on the other hand, that the intermediaries properly disallowed the capitalization of such a return because return on equity capital is not a cost. Thus, the crux of this issue is whether a return on equity capital is a cost under the Medicare Act. 37 97 In support of their position, the plaintiffs note that 42 C.F.R. Sec. 405.402(c) refers to costs such as depreciation, interest on borrowed funds, a return on equity capital (in the case of proprietary providers), and other costs.... (Emphasis added.) They also note that section 405.402(f) provides that a return on equity capital of proprietary facilities is an allowable cost in profit-making organizations. (Emphasis added.) Moreover, they also note that, for example, we said in Homan & Crimen, Inc. v. Harris, supra, at 1205, the Secretary's regulations allow reimbursement of indirect costs required for patient care, such as depreciation on buildings and equipment, interest incurred on loans, and a return on equity capital. (Emphasis added.) But while the plaintiffs cite several instances where both the Medicare regulations and judicial decisions do refer to a return on equity as a cost, we believe they fail to take into account the legislative history of the Medicare reimbursement scheme and the weight of recent court decisions specifically focusing on this question. 98 Nowhere in the Medicare regulations is the word cost defined. It is used interchangeably with the words allowance and expense to mean something which is paid under the Medicare statute. Because corporate providers are paid a return on equity capital, the regulations and the courts often refer to this return as a cost, probably because a return on equity capital is included in the provider's program reimbursement. However, a return on equity is a profit, not a cost, and it has its own independent basis in the Medicare Act. While reimbursable expenses paid by Medicare all fall under the reasonable costs provision, 42 U.S.C. Sec. 1395x(v)(1)(A), a return on equity capital is provided for under section 1395x(v)(1)(B). Moreover, recent judicial decisions have carefully examined the legislative history of the return on equity capital provision and have demonstrated persuasively that a return on equity is not a reasonable cost as contemplated by the Medicare Act. See St. Francis Hospital Center v. Heckler, 714 F.2d 872 (7th Cir.1983); Hospital Authority of Floyd County, Georgia v. Heckler, 707 F.2d 456 (11th Cir.1983); Saline Community Hospital Association v. Schweiker, 554 F.Supp. 1133 (E.D.Mich.1983). We believe these decisions to be sound and do not believe that reiterating the courts' analyses is necessary. Thus, because a return on equity in aircraft used for construction is not a cost, such as depreciation of the aircraft, it cannot be added to the historical cost of the facilities being constructed. 38 Thus, we affirm the district court's judgment on this issue. 99