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IRS Releases Final Version of IBOR Transition Regulations | Cadwalader, Wickersham & Taft LLP


On December 30, 2021, the Treasury Department and the IRS issued final regulations to address the issue of taxation of changes that replace LIBOR or another offered interbank rate (a IBOR) with a tariff qualified as SOFR. Notably, the final rule eliminates the requirement in the proposed rule that the amendment results in the non-taxation of an instrument with a substantially equivalent FMV. We’ve discussed the proposed regulations here, the fair market value test here, and the related guidelines here.

The Final Rules apply to all changes, whether made through Amendment, Exchange, Withdrawal and Reissue, or otherwise, and to all “Contracts”, which are broadly defined to include all debt, equity and derivative instruments.

Here is a summary of the final settlement:

1. No tax on covered modifications

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

  • Replaces an operational rate that uses an interrupted IBOR with a qualified rate;
  • Adds a qualified rate as a fallback rate to a contract whose going rate uses an interrupted IBOR; Where
  • Replaces a fallback rate that uses an interrupted IBOR with a qualified rate.

A IBOR interrupted 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 replacement rate based on SOFR or other qualified replacement rate, provided that it is in the same currency as the discontinued IBOR or that it is reasonably expected to measure contemporary changes in the cost of newly borrowed funds in this motto.

2. Modifications not covered tested separately

Some modifications may include covered and uncovered components. Uncovered changes should be tested on a stand-alone basis under the general change rules to determine if they cause a taxable event. When an uncovered modification is made at the same time as a covered modification, taxpayers should test the uncovered modification as if the contract already included the covered modification.

3. One-off payments

Covered changes that override a going rate may include a qualifying one-time payment, which is a one-time cash payment that compensates a portion for the difference between the interrupted IBOR and the replacement rate. Any other compensatory payment is not eligible.

4. Associated modifications

The changes covered include all associated changes, which are:

  • Technical, administrative or operational changes reasonably necessary to adopt or implement a Covered Change, such as changes in payment periods or in determining interest; Where
  • Ancillary cash payments to compensate for small valuation differences resulting from these associated changes.

5. Multiple fallback rates

A single qualified rate can be made up of multiple fall rates, such as an interest rate cascade. The regulation contains the following rules for testing multiple fallback rates:

  • Each rate of decline must be eligible on a stand-alone basis.
  • Indeterminate fallback rates, such as those based on the discretion of a calculation agent, are treated as unqualified.
  • Remote fallback rates are treated as qualified.

6. Compliant regulatory changes

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

  • REMIC. A securitization vehicle will not fail to qualify as a REMIC only because its regular interest is changed to reference a qualified rate in accordance with regulations, or is subject to a reduction in principal or interest (or similar amounts) for the 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 amendment.
  • Integration and coverage. A regulatory change will generally not result in a taxpayer being treated as ceding or terminating a leg of an embedded transaction or hedge, as long as the resulting financial instrument qualifies for hedging rules within 90 days after the first modification of a component contract.
  • Acquired rights FATCA. A regulatory change will not cause an instrument to lose its grandfathered status under FATCA.
  • Conditional payment debt securities. The use by a floating rate debt instrument of a replacement rate qualified as a fallback rate will not result in the treatment of that debt instrument as a contingent payment debt instrument and will not create or increase the amount. the initial issue discount on the instrument.

seven. Effective date

The regulation applies to changes that occur no later than 60 days after publication in the federal register (scheduled for January 4, 2022). Taxpayers can usually rely on regulations for past amendments if they and their related parties apply them consistently.

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