Grant Thornton Insight: The new regulations are generally intended to minimize the impact of the transition away from the use of certain IBORs used in debt instruments, derivatives and other contracts. However, it is highly recommended that taxpayers consult their tax advisors related to any modification to an existing debt instrument or contract.
The IRS released final regulations on Dec. 31 (TD 9961) providing guidance on the transition from interbank offered rates, or IBORs (e.g., the London Interbank Offered Rate (LIBOR)), that are used in debt instruments and other financial contracts. The final regulations are effective on March 7, 2022, and replace existing proposed regulations.
A broad range of financial transactions reference IBORs, including over-the-counter and exchange-traded derivatives, loans, taxable and tax-exempt bonds, floating-rate notes, and securitized products. However, the regulator that oversees LIBORs previously announced that the LIBOR may be phased out after the end of 2021. More recently, the administrator of the LIBOR announced that the publication of the overnight, one-month, three-month, six-month and 12-month USD-LIBORs will cease immediately following the publication on June 30, 2023. After June 30, 2023, the regulator may compel publishing of certain variants of LIBOR using a “synthetic” methodology, but these synthetic LIBORs are expected to be published for a limited period of time.
Various tax issues may arise when contracts, including debt instruments, are modified in anticipation of the discontinuation of the LIBOR.
The new regulations apply to contracts including debt instruments, derivative contracts, stock, insurance contracts, and lease agreements. Specifically, the regulations provide rules relating to the modification of the terms of a contract as part of the transition from the LIBOR and certain other interbank offered rates. Generally, a “covered modification,” as defined in the regulations, is not treated as the exchange of property for other property differing materially in kind under Section 1001.
A covered modification includes certain a modification, or a portion of a modification, of the terms of a contract that:
- Replaces an operative rate that references a discontinued IBOR with a qualified rate, to add an obligation for one party to make a qualified one-time payment (if any), and to make associated modifications (if any)
- Includes a qualified rate as a fallback rate to an operative rate that references a discontinued IBOR and to make associated modifications (if any)
- Replaces a fallback rate that references a discontinued IBOR with a qualified rate and to make associated modifications (if any)
The regulations also define key terms including: “qualified rate,” “discontinued IBOR,” “associated modification,” and “qualified one-time payment.”
If a covered modification is made at the same time as a noncovered modification, the regulations under Section 1001 still apply to determine whether the noncovered modification results in an exchange under Section 1001.
The final regulations also provide a list of specific modifications that are excluded from the definition of covered modification. They also provide guidance for ancillary issues related to hedging transactions, withholding, fast-pay stock, REMICs, and investment trusts.
Jeff Borghino is a partner in the corporate tax group of Grant Thornton’s Washington National Tax Office in Washington, D.C. He focuses primarily on the taxation of corporate and financial transactions, including taxable and tax-free acquisitions, general corporate tax matters, recapitalizations and debt workouts, and financial instruments. Prior to joining the Washington National Tax Office, Borghino worked in Grant Thornton’s San Francisco office as part of the federal tax group.
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