Overview
During our audit period, BCArc charged at least $651,540 in unallowable related-party expenses against its state contracts. These costs were for capital improvements, maintenance, and bookkeeping. BCArc paid for the capital improvements for properties owned by Berkshire Omega. Although Berkshire Omega has listed the cost of these capital improvements in its financial statements as an account payable to BCArc, there are no formal loan agreements or repayment schedules that establish when, if ever, Berkshire Omega must repay it. These expenses are non-program-related, because they benefited Berkshire Omega, and therefore should not have been charged to BCArc’s state contracts. BCArc could have used this $651,540 to pay for reimbursable expenses for its state-funded programs.
BCArc performs the maintenance at Berkshire Omega’s properties even though its lease agreements with Berkshire Omega require Berkshire Omega to provide it. BCArc also performs Berkshire Omega’s bookkeeping. The following table summarizes the expenses for which BCArc paid during our audit period.
Services Provided to Berkshire Omega by BCArc
|
Expense |
Fiscal Year 2018 |
Fiscal Year 2019 |
Total |
|
Bookkeeping |
$ 4,621 |
$ 5,372 |
$ 9,993 |
|
Property Maintenance |
51,402 |
102,804 |
154,206 |
|
Total |
$ 56,023 |
$ 108,176 |
$ 164,199 |
BCArc invoices Berkshire Omega for this maintenance and bookkeeping; however, each year, BCArc calculates what rent it will pay for each of the properties it rents from Berkshire Omega based on Berkshire Omega’s operating costs. These costs include payments to BCArc for its bookkeeping and maintenance. Consequently, BCArc ultimately pays for these expenses via the rent payments it makes to Berkshire Omega. In addition, since the expenses are related to the operation of Berkshire Omega and therefore are non-program expenses, BCArc should not have charged them to its state contracts.
Finally, according to OSD regulations, BCArc is only allowed to pay Berkshire Omega rent in an amount equal to either the fair market rent for the properties or Berkshire Omega’s actual costs for operating them, whichever is less. However, BCArc has not conducted a fair market rent determination for these properties since 2006. Therefore, BCArc cannot be certain that its rent payments to Berkshire Omega are consistent with OSD regulations.
Authoritative Guidance
Under 808 CMR 1.05(12), “expenses of the Contractor which are not directly related to the social service Program purposes of the Contractor” are nonreimbursable under state contracts. Since these expenses were not budgeted for in BCArc’s state contracts, they are non-program-related expenses.
In addition, 808 CMR 1.05(8) identifies which related-party transaction costs (such as rent) are reimbursable:
Costs which are associated with a Related Party transaction are reimbursable only to the extent that the costs do not exceed the lower of either the market price or the Related Party’s actual costs.
Reasons for Issue
BCArc management stated that although a fair market rent determination had not been performed since 2006, they believed they were paying below fair market rent for properties that BCArc rented from Berkshire Omega. They also stated that since BCArc controlled Berkshire Omega, capital improvements were to be repaid the following year.
BCArc management also stated that maintenance and bookkeeping were ultimately provided by Berkshire Omega through separate contracts with BCArc. However, as noted above, the maintenance expenses were to be provided by Berkshire Omega in accordance with its lease agreements, and BCArc should not be paying for any of Berkshire Omega’s expenses, since they are unallowable under OSD regulations.
Recommendations
- BCArc should cooperate with OSD to resolve any identified issues regarding nonreimbursable costs and should reimburse the Commonwealth for any such costs that OSD determines must be repaid.
- BCArc should perform a fair market rent determination for the properties it leases from Berkshire Omega annually and use this information to determine what rents it should pay Berkshire Omega for these properties (i.e., the lower of the fair market rent or Berkshire Omega’s actual costs related to the properties).
- BCArc should stop using state funds to pay for any capital improvements to Berkshire Omega’s properties and should enter into repayment agreements with Berkshire Omega for the capital improvements for which it has already paid.
- BCArc should not pay for the maintenance of Berkshire Omega’s properties or its bookkeeping expenses.
Auditee’s Response
Berkshire Omega Corporation (BO) is a non-profit entity established by BCArc to hold title to real estate occupied by BCArc. BO’s properties are 100% occupied and utilized by BCArc for residential services, day services, programming, and operations. BO was established by BCArc based on legal advice by BCArc’s counsel and with full disclosure and knowledge of the Commonwealth of Massachusetts. The relationship is well-documented and disclosed in both organizations’ financial statements as corroborated by BCArc’s independent external auditors. . . .
The main purpose of this legal structure is to keep the real estate operations (BO) separate from the organization providing services (BCArc). The structure in place meets then and current State regulations and neither organization, nor any individual, is improperly benefiting from the relationship.
As OSA recognizes, Massachusetts regulations regarding related parties govern the amount of BCArc’s lease payments to BO. 808 Mass. Reg. 1.05(8), states:
(8) Related Party Transaction Costs. Costs which are associated with a Related Party transaction are reimbursable only to the extent that the costs do not exceed the lower of either the market price or the Related Party’s actual costs. (Emphasis added.)
BO leases the real estate to BCArc at cost. . . . It does not make a profit. BO’s costs include bookkeeping, maintenance and capital improvements. The amount of the rent is determined annually by BCArc’s external auditors and is based on the previous year’s expenses. In accordance with Massachusetts regulation 1.05(8), BCArc’s lease payments are based on BO’s actual costs—including bookkeeping, maintenance and capital improvements. . . .
It is difficult to reconcile OSA’s statement that “BCArc should not be paying for any of Berkshire Omega’s expenses” when Massachusetts regulations require that BCArc pay “the lower of either the market price or the Related Party’s actual costs.” If it is preferred that BCArc make a single lease payment based on BO’s actual costs, rather than reimbursing BO for its actual costs, BCArc is willing to do so.
Because BO is a nonprofit organization that leases its real estate to BCArc at cost, BCArc and BO are confident that BCArc’s lease payments are below the fair market rental rate. Nevertheless, because BCArc has not recently obtained a fair market rent determination for the leased properties, BCArc will obtain such a determination and will update its leases to reflect any necessary rental changes.
As a nonprofit entity operating at cost, BO has no retained surplus and therefore does not have funds to make capital purchases. BCArc therefore lends funds to BO for capital projects. All funds advanced to BO are drawn from BCArc’s “Retained Surplus” accounts. State funds were not used to advance monies to BO. A majority of the funds advanced during the audit period were used by BO to purchase land for new housing at the request of the State. There are no current outstanding receivable balances owed to BCArc by BO. . . . In the future BCArc will document advances to BO as no-interest loans.
Finally, neither BCArc nor BO are aware of any issues that would have made payments between the two non-profit entities nonreimbursable as asserted by OSA. BCArc’s auditors’ report states:
Although BCArc’s primary funding is from state contracts, it does have other significant sources of revenue. While we don’t anticipate that ultimately there will be any expenses deemed to be non-reimbursable as a result of this audit, any expenses that might be deemed so would have been funded by those other sources, would not have been charged to state contracts, and therefore would not result in a reimbursement to the Commonwealth. . . . (Emphasis added.)
Auditor’s Reply
OSA acknowledges the relationship between BCArc and Berkshire Omega and has provided a detailed description of this relationship in this report. OSA does not take issue with this relationship but rather with BCArc’s payments to Berkshire Omega. Our report correctly points out that BCArc should only pay Berkshire Omega for expenses that are allowable under OSD regulations. As noted above, we found several expenses that BCArc paid during our audit period that were not allowable under OSD regulations. Specifically, BCArc paid for $487,341 in capital improvements to properties owned by Berkshire Omega. These expenses are for assets that are not owned by BCArc and are non-program-related. In its response, BCArc states that because Berkshire Omega is a nonprofit entity like BCArc, it does not have sufficient funds to make these capital purchases. However, with its response, BCArc provided documentation that indicates that Berkshire Omega does not owe it any money related to these capital improvements. Thus Berkshire Omega apparently was able to obtain funding from some source to pay for them. Of particular concern is that although Berkshire Omega listed the cost of the capital improvements in its financial statements as an account payable to BCArc, there was no formal loan agreement or repayment schedule that established when, if ever, Berkshire Omega must repay it.
In its response, BCArc states “All funds advanced to [Berkshire Omega] are drawn from BCArc’s ‘Retained Surplus’ accounts. State funds were not used to advance monies to [Berkshire Omega].” However, this is not accurate, because the source of the funds in BCArc’s Retained Surplus account is state contract funding, which is subject to OSD regulations. Surplus funds cannot be used to pay for any expenses that are unallowable under OSD regulations, such as the related-party transactions discussed above.
Regarding the maintenance expenses, as noted above, BCArc’s leases with Berkshire Omega for the properties in question include a provision for Berkshire Omega to pay for property maintenance. Therefore, it is unclear why BCArc would provide these services if Berkshire Omega believed it could provide or pay for them as stated in the leases. Further, BCArc gave us documentation that indicated that the costs of bookkeeping and maintenance were included in Berkshire Omega’s rent calculations for the properties it leased to BCArc. Thus BCArc pays for these expenses twice: once by paying directly and again in its rent. Moreover, although OSD regulations allow organizations to pay for certain related-party expenses, state contract funds are not to be used to perform services related to the operation of the related party, such as bookkeeping and maintenance.
Finally, although we acknowledge that BCArc had other non-state funding sources, it did not indicate in its UFRs that any non-state contract funding was used to pay for any of the expenses discussed in this finding. Based on its response, BCArc is taking some measures to address our concerns in this area. We urge it to fully implement our recommendations.
| Date published: | May 25, 2021 |
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