Ruling clarified UBIT exemption for swaps.

• Author: Ben-Ami, Andrew R.
• Position: Brief Article

After a period of reflection, the IRS has ruled that income earned on interest rate swaps and currency swaps by exempt organizations will not be subject to the unrelated business income tax (UBIT). This ruling will clarify the future treatment of these investment vehicles in the hands of tax-exempt organizations.

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...