based upon a corporation's net income. As such, plaintiff hospitals' franchise tax liability resulted from profit earned in providing medical services. Therefore, such liability was not a cost related to patient care but rather one directly related to investment. In this regard, the Administrator pointed out that except for the return on equity capital allowed by 42 C.F.R. § 405.429, costs related to investment are not allowed under the Medicare program. In response to plaintiff hospitals' contention that disallowing franchise taxes paid in Florida and California arbitrarily discriminates between providers in those two states and those in states where a basis other than net income is utilized, the Administrator pointed out that the Medicare program was not designed to assure that providers in different states would retain the same amount of after-tax income. The rate of tax and the types of tax are, the Administrator stated, the responsibility of the individual states.
In his decision, the Administrator also noted the providers' contention that the California and Florida franchise taxes are not income taxes but taxes imposed on corporations for the privilege of doing business within their respective states. He concluded, however, that while this distinction may be significant in other areas of state and federal law, it is not significant under Medicare principles which make the basis for the tax the decisive factor. In this regard, the Administrator noted that it was beyond question that the basis for the California and Florida franchise taxes is net income.
A second question concerning franchise taxes at issue in this proceeding is whether franchise tax liability should be considered in determining the net working capital necessary for the proper operation of patient care activity. Such necessary net working capital forms part of a proprietary provider's equity capital on which the return on equity capital, allowed under 42 C.F.R. § 405.429(b), is computed. As net working capital is obtained by subtracting a provider's current liabilities from its current assets, the effect of including franchise tax liability in this computation is to decrease the equity capital in the return on equity capital computation, thereby reducing the provider's return. In their cost determinations, the fiscal intermediaries included franchise tax liability in this computation. In his affirmance of the intermediaries' and the Provider Reimbursement Review Board's decision, the Administrator explained that the intent of the regulation, 42 C.F.R. § 405.429, is to allow a return only on that portion of equity capital which is related to patient care. Because franchise taxes are not related to patient care, the Administrator reasoned, it is necessary to remove the liability for franchise taxes from a provider's working capital which forms part of the computation for the return on equity.
Plaintiffs contend that the Administrator's decision is inconsistent with 42 U.S.C. §§ 1395f(b) and 1395x(v). The former sets forth the general proposition that a provider is to be reimbursed for its reasonable costs of providing medical services. "Reasonable cost" is determined in accordance with 42 U.S.C. § 1395x(v)(1)(A), which requires that providers be reimbursed for the costs actually incurred, including direct and indirect costs found not to be "unnecessary in the efficient delivery of needed health services." Plaintiffs argue that because a franchise tax is a cost of doing business, it should be reimbursed as indirectly related to patient care.
The Court finds, however, that liability for franchise taxes based upon net income
is not a cost incurred in providing medical services. Liability for such a tax accrues only where a hospital earns a profit; it is a direct consequence of an investment. Were a hospital at the break-even point, it would incur no franchise tax as a result of income.
Consequently, the franchise tax based on net income is not necessary for the "efficient delivery of needed health services" because it arises merely as a result of a provider's desire for profit.
As such, franchise taxes based on net income are not reimbursable under the Medicare Act. See Sierra Vista Hospital, Inc. v. Weinberger, CCH Medicare and Medicaid Guide P 27,440 (C.C.A.1975).
Plaintiffs contend that there should be no difference in effect between franchise taxes based on income and those based on other criteria. In other words, according to plaintiffs, franchise taxes should either be included or not, but the basis of the tax should be irrelevant. This result, however, overlooks the purpose of the Medicare program, which is to reimburse providers only for their reasonable costs and actual costs incurred in Rendering medical services to Medicare beneficiaries. A connection between the tax and the rendering of medical services is essential. Whether such a connection exists can only be determined by a consideration of why the tax is imposed. If the tax is imposed because of the amount of income accrued, this basis for the tax is too remotely related to the furnishing of medical care to be reimbursed.
Therefore, the basis for the franchise tax is relevant and may properly be considered by the Secretary.
Plaintiffs next argue that Medicare should reimburse Florida and California franchise taxes because return on equity allowed under the program generates such tax liability. In short, plaintiffs seem to be arguing that because Medicare's return on equity provision encourages profit making, it would be unfair for the Secretary to deny reimbursement for costs generated by the profit. First, the mere fact that a specific Medicare provision encourages profit making does not transform all costs resulting from such profit into costs of providing medical services. Otherwise, all income taxes would be reimbursable and this clearly was not Congress's intent in enacting the Medicare Act. Second, this argument turns the return on equity capital provision on its head. The purpose of the provision was to provide an incentive to providers, in addition to reimbursement of their actually incurred costs, to provide medical services to Medicare beneficiaries. However, Congress expressly limited the amount of such reimbursement to one and one-half times the average of the rates of interest on obligations issued for purchase by the Federal Hospital Insurance Trust Fund. 42 U.S.C. § 1395x(v)(1)(B). Therefore, the Court rejects plaintiffs' attempt to convert a provision that expressly limits reimbursement into a basis for expanding it.
Furthermore, plaintiffs claim that failure to reimburse providers in Florida and California for franchise taxes paid to those states arbitrarily discriminates against providers of services in these states as opposed to states where a franchise tax is measured by criteria other than net income. This argument overlooks the policy underlying the Medicare Act which explains the reason for the distinction between franchise taxes not based on net income and those based on it. The Act is not designed to correct differences in the methods used by various states in computing their franchise taxes. The purpose of the Medicare program is to reimburse providers for their reasonable costs, not to ensure providers in different states the same after-tax income. In this way, the distinction is far from arbitrary.
Next, plaintiffs contend that Medicare's failure to reimburse franchise taxes based upon net income results in these taxes being borne entirely by private paying patients, which is expressly prohibited by 42 U.S.C. § 1395x(v)(1)(A). This argument assumes the conclusion; that is, while this provision does provide that "necessary costs of efficiently delivering covered services" not be borne by patients not covered by the Act, the provision is only violated If franchise taxes based on net income are "necessary costs of efficiently delivering covered services." Because, as has already been demonstrated, these taxes are not such costs, the provision is not violated.
Moreover, plaintiffs allege that failure to reimburse franchise taxes results in profit and nonprofit providers being treated unequally in contravention of 42 C.F.R. § 405.402(b)(5). First, that provision only requires nonprofit and profit making organizations to be treated "equitably," not necessarily equally. It is equitable to reimburse the franchise tax of a nonprofit provider because that tax is related to patient care, while refusing to reimburse the franchise tax of a profit making provider which is related to income. Second, because of the return on equity provision which is only available to profit making hospitals, the reimbursement to them may well exceed the reimbursement to nonprofit hospitals. Therefore, plaintiffs' point proves too much; to adopt its rationale would eliminate the return on equity provision because it is not available to nonprofit hospitals.
Finally, plaintiffs argue that if franchise taxes are not reimbursable, it is inconsistent to include franchise liability in the return on equity capital computation. For purposes of the computation of a reasonable return, equity capital is defined by 42 C.F.R. § 405.429(b) as follows:
(1) The provider's investment in plant, property and equipment Related to patient care (net of depreciation) and funds deposited by a provider who leases plant, property, or equipment Related to patient care and is required by the terms of the lease to deposit such funds (net of noncurrent debt related to such investment or deposited funds), and
(2) Net working capital maintained for necessary and proper operation of Patient care activities. (Emphasis supplied).