The US Internal Revenue Service released final regulations on December 30 that provide that certain changes to debt instruments, derivative contracts, and other contracts to change the reference rate due to the discontinuation of the London Interbank Offered Rate (LIBOR) and other interbank offered rates will not result in a tax realization event.
LIBOR and related rates serve as benchmark rates for numerous US financial products. However, the relevant UK regulator has announced that LIBOR will be phased out after 2021, with USD LIBOR rate publication to cease after June 2023. A US governmental committee has recommended an alternative, replacement rate. However, amendments to financial contracts to adopt a new reference rate – absent the current tax rules – could create tax liabilities for US income tax purposes.
To facilitate the transition from LIBOR, the new final rules provide that no tax realization event will occur for a “covered modification” to a financial contract in accordance with the regulations. The rules are tailored to only allow tax-free modifications for changes related to the LIBOR transition (covered modifications) and specifically exclude certain other modifications
The rules specify that the covered modifications of a debt instrument, derivative, or other contract due to the rate transition will not be treated as an exchange of property for other property differing materially in kind or extent under Internal Revenue Code section 1001. They define “contract” broadly to include not only debt instruments and derivative contracts but also insurance contracts, stock, leases, and other contractual relationships.
The final regulations adopt with some changes proposed regulations published in October 2019. They include structural changes relative to the proposed regulations intended to simplify the operative rules.
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