IRS defers embedded loan rule for notional principal contracts

Tax Hot Topics: Notional principal contractsThe IRS recently amended temporary regulations (T.D. 9719) under Treas. Reg. Sec. 1.446-3T to change the applicability date of the embedded loan rule under Treas. Reg. Sec. 1.446-3T(g)(4). The final regulations were initially issued on May 8, 2015.

Pursuant to the embedded loan rule, a notional principal contract (NPC) with one or more nonperiodic payments is treated as two separate transactions consisting of (i) an on-market, level payment swap and (ii) one or more loans that must be accounted for by the parties independently of the swap.  

The regulations provide two exceptions to the general rule. First, the embedded loan rule does not apply to an NPC if the term is one year or less, per Treas. Reg. Sec. 1.446-3T(g)(4)(ii)(A). Second, the embedded loan rule does not apply to an NPC subject to certain margin or collateral requirements, per Treas. Reg. Sec. 1.446-3T(g)(4)(ii)(B).

Under the originally issued final regulations, the embedded loan rule was set to apply to NPCs entered into on or after Nov. 4, 2015. However, the amendment to Treas. Reg. Sec. 1.446-3T(j) provides that the applicability date of the embedded loan rule is the later of Jan. 1, 2017, or 180 days after the date that final regulations are published in the Federal Register.


Jeff Borghino
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