Notional principal contract

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A notional principal contract (NPC) is an umbrella term for contracts based on an underlying notional amount. The notional amount is an amount specified in the contract and based on which, certain calculations are made. NPCs involve two parties who agree contractually to pay each other amounts at specified times, based on the underlying contract. Generally, when amounts are due under the contract at the same time, they are netted and only one payment is made.

[edit] Definition Provided in Treasury Regulations

For tax purposes, Treasury Regulations define a Notional Principal Contact as "a financial instrument that provides for the payment of amounts by one party to another at specified intervals calculated by reference to a specified index upon a notional principal amount in exchange for specified consideration or a promise to pay similar amounts." (Treas. Reg. § 1.446-3(c)(1)(i)). It is not defined in the Internal Revenue Code itself.

[edit] Examples Provided in Treasury Regulations

The Regulations also provide examples of contracts that are treated as NPCs, including "interest rate swaps, currency swaps, basis swaps, interest rate caps, interest rate floors, commodity swaps, equity swaps, and similar agreements." (Treas. Reg. § 1.446-3(c)(1)(i)). Note that commodities that are not swaps or any other contract under which a delivery of property is allowed does not qualify as an NPC.

[edit] Tax Consequences

Any amounts received under an NPC must be recognized by the taxpayer. (Treas. Reg. § 1.446-3(e)(2)(i)). When there is an NPC that stretches over a calendar year or more, for any amount not yet received by the taxpayer, a ratable amount must be recognized. (Id.)