December 22, 1992

Mr. T. J. Sullivan

Technical Assistant (Health Care Industries)

Office of the Associate Chief Counsel

(Employee Benefits and Exempt Organizations)

Internal Revenue Service

Washington, D.C. 20224

Dear Mr. Sullivan:

You have informally inquired about our views concerning the application of the Medicare and Medicaid anti-kickback statute, 42 U.S.C. 1320a-7b(b), to certain types of situations involving the acquisition of physician practices. In the situations in question, the physician practices would be acquired either by a hospital or by another entity which would also acquire one or more hospitals (and potentially other health care providers as well). The physicians from these practices would continue to treat patients and be affiliated (through an employment relationship or otherwise) with the hospital or other entity which acquired their practices. The acquisition of the physician practices could arise through a number of different methods or arrangements and the resulting or ensuing relationships or affiliations could vary. However, the end result in each case would be the common ownership or control of both hospitals and physician practices by a single entity. We are responding to your inquiry in general terms and not in reference to any specific fact pattern(s).

Typically, in the case of the acquisition of a physician practice by a hospital or other entity, there is a large, up front payment to the physician, often of many hundreds of thousands of dollars or more. This sum is asserted to be payment for the purchase of the assets of the practice. There are also payments made to the physician subsequent to the sale of the practice where the physician becomes employed by the hospital or entity or otherwise enters into a contract to provide services to patients. These payments are asserted to be compensation for services rendered to patients by the physician.

As you know, the anti-kickback statute provides for penalties against anyone who knowingly and willfully solicits, receives, offers or pays remuneration, in cash or in kind, to induce or in return for:

A. referring an individual to a person for the furnishing or arranging for the furnishing of any item or service payable under the Medicare or Medicaid programs, or

B. purchasing, leasing or ordering or arranging for or recommending purchasing, leasing, or ordering any good, facility, service or item payable under the Medicare or Medicaid programs.

Persons who violate the anti-kickback statute are subject to criminal penalties and/or exclusion from participation in the Medicare and Medicaid programs. The anti-kickback statute sets forth certain specific exceptions to the general prohibition against remuneration, and specifically authorizes this Department to promulgate, by regulation, additional payment practices (known as "safe harbors") which will be immune from prosecution. The Department published final "safe harbor" regulations on July 29, 1991 (42 C.F.R. 1001.952, 56 Fed. Reg. 35,952) setting forth eleven regulatory exceptions to the anti-kickback statute. Among the safe harbors included in the regulations were provisions relating to employees and sale of practitioner practices. Additional safe harbor provisions relating to "managed care" entities were published as final regulations (with comment period) on November 5, 1992 (57 Fed. Reg. 52,723).

We have significant concerns under the anti-kickback statute about the type of physician practice acquisitions described in your inquiry to us. Frequently, hospitals seek to purchase physician practices as a means to retain existing referrals or to attract new referrals of patients to the hospital. Such purchases implicate the anti-kickback statute because the remuneration paid for the practice can constitute illegal remuneration to induce the referral of business reimbursed by the Medicare or Medicaid programs.(1)

We believe the same concerns raised by hospital purchases of physician practices could also arise where another entity (such as a foundation) purchases a physician practice, when such foundation also owns or operates a hospital which benefits from referrals from those physicians.

In particular, we are concerned that the remuneration paid in connection with or as a result of the acquisition of a physician's practice could serve to interfere with the physician's subsequent judgment of what is the most appropriate care for a patient. The remuneration could result in the delivery of inappropriate care to Medicare or Medicaid beneficiaries by inducing the physician to utilize the affiliated hospital rather than another hospital or less costly facility which may provide better or more appropriate care. It could also have the effect of inflating costs to the Medicare or Medicaid programs by causing physicians to overuse inappropriately the services of a particular hospital (or other affiliated provider). This higher cost could occur directly because of the higher rates of that hospital or the ordering of unnecessary serviced or indirectly as a result of lessened competition in the marketplace. Finally, these arrangements could significantly interfere with a beneficiary's freedom of choice of providers. All these considerations are the very abuses that the antikickback statute was designed to prevent. We recently addressed these same types of possible abuses in an Office of Inspector General Special Fraud Alert entitled "Hospital Incentives to Physicians". A copy of that Fraud Alert is enclosed for your information.

The following are specific aspects of physician practice acquisition or subsequent activities that may implicate or result in violations of the anti-kickback statute. Our comments focus primarily on two broad issue categories: (1) the total amount paid for the physician practice and the nature and type of items for which the physician receives payment; and (2) the amount and manner in which the physician is subsequently compensated for providing services to patients.(2)

Under the anti-kickback statute, either of the above categories of payment could constitute illegal remuneration. This is because under the anti-kickback statute, the statute is violated if "one purpose" of the payment is to induce the referral of future Medicare or Medicaid program business. United States v. Greber, 760 F.2d 68, 69 (3rd Cir. 1985) cert. denied, 474 U.S. 988 (1985); United States v. Kats, 871 F.2d 105, 108 (9th Cir. 1989). Thus, it is necessary to scrutinize the payments (including the surrounding facts and circumstances) to determine the purpose for which they have been made. As part of this undertaking, it is necessary to consider the amounts paid for the practice or as compensation to determine whether they reasonably reflect the fair market value of the practice or the services rendered, in order to determine whether such items in reality constitute remuneration for referrals. Moreover, to the extent that a payment exceeds the fair market value of the practice or the value of the services rendered, it can be inferred that the excess amount paid over fair market value is intended as payment for the referral of program-related business. United States v. Lipkis, 770 F.2d 1447 (9th Cir. 1985).

When considering the question of fair market value, we would note that the traditional or common methods of economic valuation do not comport with the prescriptions of the anti-kickback statute. Items ordinarily considered in determining the fair market value may be expressly barred by the anti-kickback statute's prohibition against payments for referrals. Merely because another buyer may be willing to pay a particular price is not sufficient to render the price paid to be fair market value. The fact that a buyer in a position to benefit from referrals is willing to pay a particular price may only be a reflection of the value of the referral stream that is likely to result from the purchase.(3)

Accordingly, when attempting to assess the fair market value (as that term is used in an anti-kickback analysis) attributable to a physician's practice, it may be necessary to exclude from consideration any amounts which reflect, facilitate or otherwise relate to the continuing treatment of the former practice's patients. This would be because any such items only have value with respect to the on-going flow of business to the practice. It is doubtful whether this value may be paid by a party who could expect to benefit from referrals from that ongoing practice.(4) Such amounts could be considered as payments for referrals. Thus, any amount paid in excess of the fair market value of the hard assets of a physician practice would be open to question. Similarly, in determining the fair market value of services rendered by employee or contract physicians, it may be necessary to exclude from consideration any amounts which reflect or relate to past or future referrals or any amounts which reflect or are affected by the expectation or guarantee of a certain volume of business (by either the physician or the hospital). Specific items that we believe would raise a question as to whether payment was being made for the value of a referral stream would include, among other things:

-- payment for goodwill,

-- payment for value of ongoing business unit,

-- payment for covenants not to compete,

-- payment for exclusive dealing agreements,

-- payment for patient lists, or

-- payment for patient records.

Payments for the above types of assets or items are questionable where, as is the case here, there is a continuing relationship between the buyer and the seller and the buyer relies (at least in part) on referrals from the seller.

We believe a very revealing inquiry would be to compare the financial welfare of the physicians involved before and after the acquisition. (One can expect to find projections on this subject among materials given to prospective physician participants in these arrangements.) If the economic position of these physicians is expected to significantly improve as a result of the acquisition, it is likely that a purpose of the acquisition is to offer remuneration for the referrals which these physicians can make to the buyer. Another revealing inquiry would be to compare referral patterns before and after the acquisition, specifically, whether the sellers become increasingly "loyal" to the buyer. (Obviously, this inquiry would only occur if the acquisition took place, but it is a potential topic to study in the future to the extent acquisitions occur and are subject to audit or investigation by the Internal Revenue Service.)

In sum, these arrangements raise grave questions of compliance with the anti-kickback statute. We believe that many of these arrangements are merely sophisticated disguises to share the profits of business at a hospital with referring physicians, in order to induce the physicians to steer referrals to the hospital.

We hope this letter has provided helpful information in response to your informal inquiry.



D. McCarty Thornton

Associate General Counsel

Inspector General Division



1. Since tax exempt hospitals are generally required to participate in the Medicare and-Medicaid programs as a condition of obtaining or maintaining their tax exempt status, the antikickback statute is necessarily a significant issue to be addressed by them.

2. We would also note that while the anti-kickback statute contains a statutory exemption for payments made to employees by an employer, the exemption does not cover any and all such payments. Specifically, the statute exempts only payments to employees which are for "the provision of covered items or services". Accordingly, since referrals do not represent covered items or services, payments to employees which are for the purpose of compensating such employees for the referral of patients would likely not be covered by the employee exemption.

3. This deviation from the normal "economic" model was made expressly clear in the safe harbor provisions. For purposes of determining the value of space or equipment rentals, "fair market value" is specifically defined to exclude the "additional value one party . . . would attribute to the property [equipment] as a result of its proximity or convenience to sources of referrals or business otherwise generated". 42 C.F.R. 1001.952(b) and (c), 56 Fed. Reg. 35971-35973, 35985.

4. We note that these physician practice acquisitions do not fall within the parameters of the existing safe harbor provisions on the sale of practitioner practices. In the final safe harbor regulations, we expressly declined to expand the scope of the safe harbor to cover purchases of physician practices by hospitals or other types of entities or to situations where the seller remains in a continuing position to make referrals or influence referrals to the buyer because of our concerns that many of such purchases were in fact merely attempts to provide remuneration in return for a future stream of referrals. See Preamble to the final safe harbor regulations, 56 Fed. Reg. at 35975. We also attempted to deal with arrangements which have the potential to lock in a referral stream in the safe harbor provisions dealing with joint ventures. See 42 C.F.R. 1001.952(a), 56 Fed. Reg. 35,984-85.