The US Treasury Department and the US Internal Revenue Service (IRS) have issued proposed regulations REG-118784-18 to provide guidance on the tax consequences of the transition to the use of reference rates other than interbank offered rates (IBORs) in debt instruments and non-debt contracts (i.e.including interest rate swaps, cross-currency swaps and equity swaps).
The London Interbank Offered Rate (LIBOR) is the global benchmark for financial transactions with an estimated volume of USD 370 trillion. The discontinuation of LIBOR and other IBORs including USD LIBOR at the end of 2021 requires market participants to use alternative key interest rates from 1.1.2022 at the latest. The Alternative Reference Rates Committee (ARRC) of the Federal Reserve, tasked with selecting alternative rates, selected the Secured Overnight Financing Rate (SOFR) as the replacement for USD LIBOR. Other jurisdictions have selected other reference rates to replace LIBOR for their respective currencies, including the Sterling Overnight Index Average (SONIA) to replace British pound sterling LIBOR, the Tokyo Overnight Average Rate (TONAR) to replace yen LIBOR and the Tokyo Interbank Offered Rate, and the Swiss Average Rate Overnight (SARON) to replace Swiss franc LIBOR.
The proposed regulations address the possibility that modifying a debt instrument, derivative, or other financial contract to replace a reference rate based on an IBOR could be a taxable transaction resulting in the realization of income, deduction, gain or loss for US Federal income tax purposes or could result in other tax consequences.
The proposed regulations provide relief that allows taxpayers to avoid adverse tax consequences from changing the terms of debt, derivatives, and other financial contracts to replace reference rates based on IBORs with certain alternative reference rates, such as SOFR published by the Federal Reserve Bank of New York.
The proposed regulations apply to changes to affected contracts made on or after the date on which the proposed regulations are published as final. Taxpayers and their related parties may elect to apply the proposed regulations to changes that occur before that date, provided that they apply the proposed regulations consistently.