Cadwalader Logo BrassTax Logo
IRS Publishes Final IBOR Transition Regulations

On December 30, 2021, the Treasury Department and IRS issued final regulations to address the taxability of modifications that replace LIBOR or another interbank offered rate (an IBOR) with a qualified rate like SOFR. Notably, the final regulations eliminate the proposed regulations’ requirement that the modification result in an instrument with a substantially equivalent FMV to be nontaxable. We discussed the proposed regulations here, the FMV test here, and related guidance here.

The final regulations apply to all modifications, whether effected through an amendment, an exchange, a retirement and reissuance, or otherwise, and to all "contracts," which are defined broadly to include all debt, equity, and derivative instruments.

Here is a summary of the final regulations:

1. No tax on covered modifications

Under the final regulations, a covered modification to a contract is not taxable. A covered modification is any modification that:

  • Replaces an operative rate that uses a discontinued IBOR with a qualified rate;
  • Adds a qualified rate as a fallback rate to a contract whose operative rate uses a discontinued IBOR; or
  • Replaces a fallback rate that uses a discontinued IBOR with a qualified rate.

A discontinued IBOR is any IBOR from the date an administrator or regulator announces that the rate will no longer be published until one year after the date the rate is no longer published.

A qualified rate is a SOFR-based or other qualified replacement rate, so long as it is in the same currency as the discontinued IBOR or is otherwise reasonably expected to measure contemporaneous variations in the cost of newly borrowed funds in that currency.

2. Noncovered modifications tested separately

Some modifications might include covered and noncovered components. Noncovered modifications must be tested on a standalone basis under the general modification rules to determine whether they cause a taxable event. When a noncovered modification is effected contemporaneously with a covered modification, taxpayers must test the noncovered modification as if the contract already included the covered modification.

3. One-time payments

Covered modifications that replace an operative rate can include a qualified one-time payment, which is a single cash payment that compensates a party for the difference between the discontinued IBOR and the replacement rate. Any other compensatory payments are not qualified.

4. Associated modifications

Covered modifications include any associated modifications, which are:

  • Technical, administrative, or operational modifications reasonably necessary to adopt or to implement a covered modification, such as changes to interest payment or determination periods; or
  • Incidental cash payments to compensate for small valuation differences resulting from those associated modifications.

5. Multiple fallback rates

A single qualified rate may consist of multiple fallback rates, such as an interest rate waterfall. The regulations contain the following rules for testing multiple fallback rates:

  • Each fallback rate must qualify on a standalone basis.
  • Indeterminate fallback rates, such as those that rely on the discretion of a calculation agent, are treated as nonqualified.
  • Fallback rates that are remote are treated as qualified.

 6. Conforming regulatory amendments

The regulations make a number of conforming changes that flow directly from the general non-recognition rule:

  • REMICs. A securitization vehicle will not fail to qualify as a REMIC solely because its regular interests are modified to reference a qualified rate in accordance with the regulations, or are subject to a reduction of principal or interest (or similar amounts) for reasonable costs incurred to effect the modification.
  • Grantor trusts. A grantor trust will not have an impermissible “power to vary” as a result of a covered modification.
  • Integration and hedging. A modification in accordance with the regulations generally will not cause a taxpayer to be treated as disposing of or terminating a leg of an integrated transaction or hedge, so long as the resulting financial instrument qualifies under the hedging rules within 90 days after the first modification of a component contract.
  • FATCA grandfathering. A modification in accordance with the regulations will not cause an instrument to lose its grandfathered status under FATCA.
  • Contingent payment debt instruments. A floating rate debt instrument’s use of a qualified replacement rate as a fallback rate will not cause that debt instrument to be treated as a contingent payment debt instrument and will not create or increase the amount of original issue discount on the instrument.

 7. Effective date

The regulations apply to modifications that occur on or after March 7. Taxpayers generally may rely on the regulations for earlier modifications if they and their related parties apply them consistently.


Key Contacts

Adam Blakemore
T. +44 (0) 20 7170 8697

Linda Z. Swartz
T. +1 212 504 6062

Jon Brose
T. +1 212 504 6376

Andrew Carlon
T. +1 212 504 6378

Mark P. Howe
T. +1 202 862 2236

© 2024 | Notices