Tax-exempt investors are generally exempt from federal income tax except to the extent of their "unrelated business taxable income" ("UBTI"). Certain types of income, commonly referred to as “passive income,” are excluded from UBTI. I.R.C. § 512(b). These passive incomes include capital gains and losses from trading commodity futures contracts and notional contracts on currencies.

In G.C.M. 39620 (Apr. 3, 1987), the Internal Revenue Service (“IRS”) concluded that gains and losses from commodity futures contracts are excluded from UBTI under Code section 512(b)(5). The IRS concluded that the obligation of a holder of a long position to pay for the commodity on delivery did not constitute indebtedness because it was an executory contract and neither the seller or the buyer actually held the property at the time of entering into the contract. The purchase of a long futures contract entailed no borrowing of money in the traditional sense. Similarly, the IRS found a short contract was merely an executory contract because there was no property held by the short seller that produced income and thus there could be no acquisition indebtedness.

Much of the same can be said for Notional Principal Contracts (“NPC”). The IRS has issued regulations providing that all income and gain from NPC is excluded from UBTI. See Treas. Reg. ยง 1.512(b)-1(a)(1). The reason a currency trade is considered NPC is because neither party is required to actually hold the property comprising the underlying amount. The purchase entails no borrowing of money in the traditional sense.