16. What is passive income?

As the term suggests, passive income is derived from investing in assets rather than from activities carried on in the normal course of a trade or business.

Passive income includes the portion of income that consists of:

• Dividends.
• Interest.
• Income equivalent to interest.
• Rental income and royalties, other than rental income and royalties derived in the active conduct of a trade or business conducted, at least in part, by employees of the non-financial entity (NFE)*
• Annuities.
• The excess of gains over losses from the sale or exchange of property that gives rise to passive income described previously.
• The excess of gains over losses from transactions (including futures, forwards, options, and similar transactions) in any Financial Assets.
• The excess of foreign currency gains over foreign currency losses.
• Net income from swaps.
• Amounts received under Cash Value Insurance Contracts.

The context in which the income described above is received is important. For example, where the NFE is a dealer in financial assets any such income as described above may be income from a trading activity. Where the income described above is received by a NFE and is accounted for, or is taxable, as income from trading activities, it should be included in gross income and not as passive income. 

Passive income does not include:

• Any commodity hedging transaction;
• Active business gains or losses from the sale of commodities;
• The excess of foreign currency gains over foreign currency losses;
• Net income from notional principal contracts;
• Amounts received under a cash value insurance contract; or
• Amounts received by insurance companies in connection with its reserves for insurance and annuity contracts*.

*For any defined terms please see the Table of terms and definitions.