Ruling clarified UBIT exemption for swaps.After a period of reflection, the IRS An abbreviation for the Internal Revenue Service, a federal agency charged with the responsibility of administering and enforcing internal revenue laws. has ruled that income earned on interest rate swaps Interest Rate Swap A deal between banks or companies where borrowers switch floating-rate loans for fixed rate loans in another country. These can be either the same or different currencies. and currency swaps Currency Swap A swap that involves the exchange of principal and interest in one currency for the same in another currency. Notes: Currency swaps were originally done to get around the problem of exchange controls. by exempt organizations will not be subject to the unrelated business income tax Unrelated Business Income Tax (UBIT) in the U.S. Internal Revenue Code is the tax on unrelated business income, which comes from an activity engaged in by a tax-exempt 26 USCA 501 organization that is not related to the tax-exempt purpose of that organization. (UBIT UBIT Unrelated Business Income Tax UBiT Universitetsbiblioteket I Trondheim (NTNU Library) ). This ruling will clarify the future treatment of these investment vehicles in the hands of tax-exempt tax-ex·empt adj. 1. Not subject to taxation, as the capital or income of a philanthropic organization. 2. Producing interest that is exempt from income tax: tax-exempt bonds. n. organizations. By way of background, Sec. 511 specifies that an exempt organization will be taxed on its unrelated business taxable income Under the federal tax law, gross income reduced by adjustments and allowable deductions. It is the income against which tax rates are applied to compute an individual or entity's tax liability. The essence of taxable income is the accrual of some gain, profit, or benefit to a taxpayer. , defined in Sec. 512(a)(1) as income from any regularly carried on trade or business not related to the organization's exempt purpose. For investment-type activities, Sec. 512(b) exempts from tax certain income, such as dividends, interest and payments on securities loans. The IRS has proposed amending the regulations to exclude from UBIT not only these items, but also "substantially similar income from ordinary and routine investments in connection with a securities portfolio." The Service has proposed a ruling that income from interest rate swaps and currency swaps will be considered "substantially similar" to the other types of income routinely earned from a portfolio. In simple terms, an interest rate swap is a contract between two parties to exchange interest payments on a specified principal amount for a specified period. A currency swap is an exchange of principal in two different currencies, with an agreement to repay principal at a specified date at current interest rates. Interest is generally paid by the parties based on the interest rates available in the two currencies at the inception of the agreement. Some currency swaps may provide only for interest flows, not an exchange of principal. Pending final approval, the proposed ruling is effective with respect to amounts received after Aug. 30, 1991. The UBIT exclusion will not apply if the swap positions are debt-financed. This ruling is clearly helpful to those organizations that were considering the use of swaps as a means to enhance the returns from their portfolio. The ruling and regulatory change were necessary because the form of income generated did not literally fall within the language of a statute that was originally intended for more traditional investment forms. |
|
||||||||||||||||||
Printer friendly
Cite/link
Email
Feedback
Reader Opinion