Ruling clarified UBIT exemption for swaps.
By way of background, Sec. 511 specifies that an exempt organization will be taxed on its unrelated business taxable income, 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.
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|Author:||Ben-Ami, Andrew R.|
|Publication:||The Tax Adviser|
|Article Type:||Brief Article|
|Date:||Apr 1, 1992|
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