Rule2021-28452
Guidance on the Transition From Interbank Offered Rates to Other Reference Rates
Primary source
Metadata and text below are from the Federal Register, a public-domain U.S. government work. Always verify the official published version before relying on it for any legal matter.
Published
January 4, 2022
Effective
March 7, 2022
Issuing agencies
Treasury DepartmentInternal Revenue Service
Abstract
This document contains final regulations that provide guidance on the tax consequences of the transition away from the use of certain interbank offered rates in debt instruments, derivative contracts, and other contracts. The final regulations are necessary to address the possibility that a modification of the terms of a contract to replace such an interbank offered rate with a new reference rate could result in the realization of income, deduction, gain, or loss for Federal income tax purposes or could have other tax consequences. The final regulations will affect parties to contracts that reference certain interbank offered rates.
Full Text
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[Federal Register Volume 87, Number 2 (Tuesday, January 4, 2022)]
[Rules and Regulations]
[Pages 166-182]
From the Federal Register Online via the Government Publishing Office [<a href="http://www.gpo.gov">www.gpo.gov</a>]
[FR Doc No: 2021-28452]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Parts 1 and 301
[TD 9961]
RIN 1545-BO91
Guidance on the Transition From Interbank Offered Rates to Other
Reference Rates
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Final regulations.
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SUMMARY: This document contains final regulations that provide guidance
on the tax consequences of the transition away from the use of certain
interbank offered rates in debt instruments, derivative contracts, and
other contracts. The final regulations are necessary to address the
possibility that a modification of the terms of a contract to replace
such an interbank offered rate with a new reference rate could result
in the realization of income, deduction, gain, or loss for Federal
income tax purposes or could have other tax consequences. The final
regulations will affect parties to contracts that reference certain
interbank offered rates.
DATES:
Effective date: These final regulations are effective on March 7,
2022.
Applicability date: For dates of applicability, see Sec. Sec.
1.860A-1(b)(7), 1.1001-6(k), and 1.1275-2(m)(5).
FOR FURTHER INFORMATION CONTACT: Spence Hanemann at (202) 317-4554 (not
a toll-free number).
SUPPLEMENTARY INFORMATION:
Background
This document contains amendments to the Income Tax Regulations (26
CFR part 1) under sections 860A, 860G, 1001, 1271, 1275, and 7701(l) of
the Internal Revenue Code (Code) and to the Procedure and
Administration Regulations (26 CFR part 301) under section 7701 of the
Code.
1. Discontinuation of LIBOR and Tax Implications
On July 27, 2017, the Financial Conduct Authority, the United
Kingdom regulator tasked with overseeing the London Interbank Offered
Rate (LIBOR), announced that publication of all currency and term
variants of LIBOR, including U.S.-dollar LIBOR (USD LIBOR), may cease
after the end of 2021. The administrator of LIBOR, the ICE Benchmark
Administration, announced on March 5, 2021, that publication of
overnight, one-month, three-month, six-month, and 12-month USD LIBOR
will cease immediately following the LIBOR publication on June 30,
2023, and that publication of all other currency and tenor variants of
LIBOR will cease immediately following the LIBOR publication on
December 31, 2021.
On September 29, 2021, the Financial Conduct Authority announced
that it will compel the ICE Benchmark Administration to continue to
publish one-month, three-month, and six-month sterling LIBOR and
Japanese yen LIBOR after December 31, 2021, using a ``synthetic''
methodology that is not based on panel bank contributions (synthetic
GBP LIBORs and synthetic JPY LIBORs, respectively). The Financial
Conduct Authority has indicated that it may also require the ICE
Benchmark Administration to publish one-month, three-month, and six-
month USD LIBOR after June 30, 2023, using a similar synthetic
methodology (synthetic USD LIBORs). However, these synthetic GBP
LIBORs, synthetic JPY LIBORs, and synthetic USD LIBORs are expected to
be published for a limited period of time.
Various tax issues may arise when taxpayers modify contracts in
anticipation of the discontinuation of LIBOR or another interbank
offered rate (IBOR). For example, such a modification may be treated as
an exchange of property for other property differing materially in kind
or extent for purposes of Sec. 1.1001-1(a), giving rise to gain or
loss. Such a modification may also have consequences under the rules
for integrated transactions and hedging transactions, withholding under
chapter 4 of the Code, fast-pay stock, investment trusts, original
issue discount, and real estate mortgage investment conduits (REMICs).
To minimize potential market disruption and to facilitate an orderly
transition in connection with the discontinuation of LIBOR and other
IBORs, the Treasury Department and the IRS published proposed
regulations (REG-118784-18) in the Federal Register (84 FR 54068) on
October 9, 2019 (Proposed Regulations). The Proposed Regulations
generally provide that modifying a debt instrument, derivative, or
other contract in anticipation of an elimination of an IBOR is not
treated as an exchange of property for other property differing
materially in kind or extent for purposes of Sec. 1.1001-1(a). The
Proposed Regulations also adjust other tax rules to minimize the
collateral consequences of the transition away from IBORs.
2. Rev. Proc. 2020-44
The Alternative Reference Rates Committee (ARRC), whose ex officio
members include the Treasury Department, was convened by the Board of
Governors of the Federal Reserve System and the Federal Reserve Bank of
New York in 2014. To support the transition away from USD LIBOR, the
ARRC has published recommended fallback language for inclusion in the
terms of certain cash products, such as syndicated loans and
securitizations. The ARRC has also been actively engaged in work led by
the International Swaps and Derivatives Association (ISDA) to ensure
that the contractual fallback provisions in derivative contracts are
sufficiently robust to prevent serious market disruptions when LIBOR is
discontinued or becomes unreliable. To that end, ISDA developed the
ISDA 2020 IBOR Fallbacks Protocol by which the parties to certain
derivative contracts can incorporate certain improved fallback
provisions into the terms of those contracts.
On October 9, 2020, the Treasury Department and the IRS released
Rev. Proc. 2020-44, 2020-45 I.R.B. 991, in advance of finalizing the
Proposed Regulations to support the adoption of the ARRC's recommended
fallback provisions and the ISDA 2020 IBOR Fallbacks Protocol. Rev.
Proc. 2020-44 provides that a modification within the scope of the
revenue procedure is not treated as an exchange of property for
[[Page 167]]
other property differing materially in kind or extent for purposes of
Sec. 1.1001-1(a). In addition, Rev. Proc. 2020-44 generally provides
that a modification within the scope of the revenue procedure will not
result in legging out of an integrated transaction or terminating
either leg of a hedging transaction.
3. The Final Regulations
The Treasury Department and the IRS received public comments on the
Proposed Regulations from eight commenters. Copies of these comments
are available for public inspection at <a href="https://www.regulations.gov">https://www.regulations.gov</a> or
upon request. No public hearing was requested, and none was held. After
consideration of the public comments, the Treasury Department and the
IRS adopt the Proposed Regulations as amended by this Treasury decision
(Final Regulations).
Summary of Comments and Explanation of Revisions
The Final Regulations are intended to provide special rules to help
taxpayers adjust to the discontinuation of certain widely used interest
rate benchmarks. To achieve this purpose, the Treasury Department and
the IRS have concluded that it is appropriate in this context to depart
from the ordinary tax rules to the degree and in the manner provided in
the Final Regulations. One commenter recommended that the Treasury
Department and the IRS supplement the rules in the Final Regulations
with ``rules of construction'' based on the reasonableness of
taxpayers' actions. The Treasury Department and the IRS decline to
adopt this comment because such a principles-based rule would blur the
carefully circumscribed degree and manner in which the Final
Regulations authorize taxpayers to depart from the ordinary tax rules.
Although the Final Regulations and Proposed Regulations share many
of the same fundamental rules, the structure of Sec. 1.1001-6 in the
Final Regulations differs from that of the Proposed Regulations. These
structural changes are primarily intended to simplify the operative
rules, which are in Sec. 1.1001-6(b) through (g) of the Final
Regulations. For example, while the Proposed Regulations separately
state the rules for debt and non-debt contracts, the Final Regulations
provide a single set of rules for all contracts. The Final Regulations
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 also make use of defined terms, located in
Sec. 1.1001-6(h), to streamline references to concepts that are
frequently used in the operative rules in Sec. 1.1001-6(b) through
(g). In particular, the defined term ``covered modification'' is the
cornerstone of these rules and serves to restructure several of the
fundamental rules set forth in the Proposed Regulations. For example,
Sec. 1.1001-6 of the Proposed Regulations generally provides certain
beneficial tax consequences when the parties to a contract modify the
contract to replace an IBOR-based rate with a ``qualified rate'' and
make certain ``associated modifications,'' which may include a ``one-
time payment.'' The Final Regulations unite these various elements of
the Proposed Regulations (that is, modification of a contract, an IBOR-
based rate, a qualified rate, associated modifications, and a one-time
payment) in the single defined term ``covered modification.''
1. Treatment Under Section 1001
Section 1.1001-6(a) of the Proposed Regulations generally provides
rules for applying section 1001 to a contract that is modified to
replace an IBOR-based rate or IBOR-based fallback provisions or to add
or amend fallback provisions that would replace an IBOR-based rate.
Section 1.1001-6(a) of the Proposed Regulations generally provides that
such a modification is not treated as an exchange of property under
section 1001 and extends this treatment to any reasonably necessary
conforming modifications. When modifications that qualify for this
special treatment under proposed Sec. 1.1001-6(a) occur
contemporaneously with modifications that do not qualify, the non-
qualifying modifications are subject to the ordinary rules under Sec.
1.1001-1(a) or Sec. 1.1001-3 and the modifications that qualify for
special treatment under proposed Sec. 1.1001-6(a) are treated as part
of the existing terms of the contract. Section 1.1001-6(b) of the Final
Regulations provides similar rules but makes use of the defined terms
``covered modification'' and ``noncovered modification.''
a. Treatment of Covered and Noncovered Modifications
Under Sec. 1.1001-6(b)(1) of the Final Regulations, a covered
modification of a contract is not treated as an exchange of property
for other property differing materially in kind or in extent for
purposes of Sec. 1.1001-1(a). Consequently, in the case of a debt
instrument, a covered modification to which Sec. 1.1001-6(b)(1)
applies is not treated as a significant modification for purposes of
Sec. 1.1001-3. As defined in Sec. 1.1001-6(h)(1) of the Final
Regulations, a covered modification is generally comprised of four
elements: (1) A contract with an operative rate or fallback provision
that references a discontinued IBOR; (2) a modification of that
contract (a) to replace an operative rate that refers to a discontinued
IBOR with a qualified rate and, if the parties so choose, to add an
obligation for one party to make a qualified one-time payment, (b) to
include a qualified rate as a fallback to an operative rate that refers
to a discontinued IBOR, or (c) to replace a fallback rate that refers
to a discontinued IBOR with a qualified rate; (3) any associated
modifications with respect to those modifications of the operative rate
or fallback provisions; and (4) satisfaction of rules in Sec. 1.1001-
6(j) of the Final Regulations that exclude certain modifications from
the definition of covered modification. The defined terms
``discontinued IBOR,'' ``qualified rate,'' ``qualified one-time
payment,'' and ``associated modification'' and the rules in Sec.
1.1001-6(j) of the Final Regulations that exclude certain modifications
are discussed in more detail in the sections of this preamble entitled
Discontinued IBOR, Qualified rate, Qualified one-time payments,
Associated modifications, and Fair market value requirement and
excluded modifications, respectively. A modification described in
section 4.02 of Rev. Proc. 2020-44, as supplemented by any guidance
that may be published in the Internal Revenue Bulletin, is also treated
as a covered modification. Rev. Proc. 2020-44 is discussed in more
detail in the section of this preamble entitled Rev. Proc. 2020-44. For
purposes of the definition of a covered modification, the term
``modification'' is broadly construed to include any modification,
regardless of its form. For example, a holding corporation that issued
preferred stock may modify that stock for purposes of the Final
Regulations by means of an exchange offer conducted by the
corporation's subsidiary. The term also includes any modification
regardless of whether the modification is evidenced by an express
agreement (oral or written), conduct of the parties, or otherwise. For
example, any agreement to make additional payments with respect to a
contract is a modification of that contract, regardless of whether the
parties memorialize the obligation to make those payments in an
amendment to the original contract or in a new, standalone contract.
[[Page 168]]
Although Sec. 1.1001-6(b)(1) of the Final Regulations generally
provides that a covered modification of a contract is not treated as an
exchange of property for other property differing materially in kind or
in extent for purposes of Sec. 1.1001-1(a), whether a noncovered
modification that occurs contemporaneously with the covered
modification is an exchange of property for other property differing
materially in kind or in extent is determined under the ordinary rules
in Sec. 1.1001-1(a) or Sec. 1.1001-3. The Final Regulations define a
noncovered modification as any modification or portion of a
modification of a contract that is not a covered modification. Two
commenters asked whether pairing a modification that would otherwise
qualify for beneficial treatment under the Proposed Regulations with a
contemporaneous modification that does not so qualify prevents both
modifications from benefitting from the Proposed Regulations. The
reference to a ``portion of a modification'' in the definitions of
covered modification and noncovered modification in the Final
Regulations indicates that a modification is a noncovered modification
only to the extent that it fails to be a covered modification.
Two commenters requested that the Treasury Department and the IRS
clarify whether, following a covered modification by which the parties
add or amend fallback provisions, the change to the terms of the
contract that results from the activation of the new fallback
provisions must be tested separately at the time of activation to
determine whether that change is an exchange of property for other
property differing materially in kind or in extent for purposes of
Sec. 1.1001-1(a). As is ordinarily the case, a change to the terms of
the contract that results from the activation of a fallback provision
must be tested at the time of activation to determine whether that
change results in such an exchange under Sec. 1.1001-1(a). If the
change resulting from the activation of a fallback is a covered
modification under Sec. 1.1001-6(h)(1) of the Final Regulations, then
the special rules provided in the Final Regulations for covered
modifications apply to that change. Otherwise, whether that change is
an exchange of property for other property differing materially in kind
or in extent is generally determined under Sec. 1.1001-3 for debt
instruments and under Sec. 1.1001-1(a) for other kinds of contracts.
b. Discontinued IBOR
Section 1.1001-6(h)(4) of the Final Regulations defines
``discontinued IBOR,'' a term not used in the Proposed Regulations.
Sections 1.860G-1(e) and 1.1275-2(m) of the Final Regulations also
incorporate this definition. Under this new definition, a discontinued
IBOR is generally an IBOR that will be discontinued, and an IBOR ceases
to be a discontinued IBOR a year after the IBOR's discontinuation. The
purpose of this new definition is to tailor the relief provided in the
Final Regulations to better match the problem that the Final
Regulations are intended to address.
One commenter requested that the Final Regulations apply when the
parties to a contract modify the terms of the contract after the
existing fallback provisions have already replaced all references to
the IBOR with another rate. The commenter noted that, in the case of
some widely held debt instruments, securing the consent of enough
holders to modify the terms of the debt instrument may delay the
modification so that the existing fallback provisions are triggered
before the modification is complete. In such cases, the Proposed
Regulations would not apply to the modification because the qualified
rate would not be replacing an IBOR-based rate. The purpose of the
Final Regulations is to facilitate the transition away from
discontinued IBORs in order to avoid the market disruption that may
occur if parties to contracts referencing discontinued IBORs fail to
transition before the discontinued IBOR ceases. The change suggested by
the commenter is not necessary to achieve this purpose. Moreover, the
discontinuation of the most commonly used tenors of USD LIBOR has been
deferred until June 30, 2023, giving parties to contracts such as those
described by the commenter an additional 18 months to act. Accordingly,
the Final Regulations do not adopt this comment.
As discussed in the section of this preamble entitled
Discontinuation of LIBOR and Tax Implications, the ICE Benchmark
Administration will continue to publish synthetic GBP LIBORs and
synthetic JPY LIBORs for a limited time after December 31, 2021, and
may publish synthetic USD LIBORs for a limited time after June 30,
2023. The Treasury Department and the IRS have determined that, for
purposes of the Final Regulations, these synthetic LIBORs are a
continuation of the currency and tenor variant of LIBOR that they
succeed. Thus, for example, three-month sterling LIBOR became a
discontinued IBOR on March 5, 2021, the date on which the ICE Benchmark
Administration announced that it would permanently cease to publish
three-month sterling LIBOR, and will cease to be a discontinued IBOR
one year after the date on which the ICE Benchmark Administration
ceases to publish the three-month tenor of synthetic GBP LIBOR.
c. Qualified Rate
The definition of ``qualified rate'' in Sec. 1.1001-6(b) of the
Proposed Regulations generally includes three elements: (1) The
putative qualified rate must appear on a list of rates eligible to be a
qualified rate in Sec. 1.1001-6(b)(1); (2) the fair market values of
the contract before and after the modification involving the putative
qualified rate must be substantially equivalent under Sec. 1.1001-
6(b)(2); and (3) the interest rate benchmark to which the putative
qualified rate refers and the relevant IBOR generally must be based on
the same currency under Sec. 1.1001-6(b)(3). The fair market value
requirement is addressed in more detail in the section of this preamble
entitled Fair market value requirement and excluded modifications.
One commenter recommended streamlining the list of rates that are
eligible to be a ``qualified rate'' in Sec. 1.1001-6(b)(1) of the
Proposed Regulations. The commenter pointed out that Sec. 1.1001-
6(b)(1)(x) of the Proposed Regulations generally includes qualified
floating rates without regard to the limitations on multiples and that
the interest rate benchmarks listed in Sec. 1.1001-6(b)(1)(i) through
(viii) of the Proposed Regulations are merely examples of qualified
floating rates. In response, the Treasury Department and the IRS have
merged Sec. 1.1001-6(b)(1)(i) through (viii) and (x) of the Proposed
Regulations into a single entry in Sec. 1.1001-6(h)(3)(ii)(A) of the
Final Regulations, which includes a non-exclusive list of rates that
are generally qualified floating rates, such as the Secured Overnight
Financing Rate published by the Federal Reserve Bank of New York
(SOFR), the Sterling Overnight Index Average, the Tokyo Overnight
Average Rate, the Swiss Average Rate Overnight, and the euro short-term
rate administered by the European Central Bank.
This commenter also suggested that Sec. 1.1001-6(b)(1)(xi) of the
Proposed Regulations, which describes any rate determined by reference
to another rate included in the list of eligible rates, is unnecessary
because any rate described in that paragraph is also described in Sec.
1.1001-6(b)(1)(x) of the Proposed Regulations, which is any qualified
[[Page 169]]
floating rate without regard to the limitations on multiples. However,
certain IBOR-based objective rates (as defined in Sec. 1.1275-5(c))
and certain IBOR-based rates on contingent payment debt instruments
(within the meaning of Sec. 1.1275-4) may not be described in Sec.
1.1001-6(b)(1)(x) of the Proposed Regulations. Accordingly, the Final
Regulations do not adopt this comment and retain both Sec. 1.1001-
6(b)(1)(x) and (xi) of the Proposed Regulations in the list of eligible
rates at Sec. 1.1001-6(h)(3)(ii)(A) and (D) of the Final Regulations,
respectively.
Other commenters suggested that the list of rates that are eligible
to be qualified rates in the Proposed Regulations be expanded to
include any rate identified by the ARRC or ISDA as a replacement for an
IBOR. The Treasury Department and the IRS have concluded that allowing
any purely private organizations the authority to add to the list of
rates eligible to be qualified rates would be inconsistent with the
carefully circumscribed degree and manner in which the Final
Regulations authorize taxpayers to depart from the ordinary tax rules.
Accordingly, the Final Regulations extend such authority only to the
ARRC and only for as long as the Federal Reserve Bank of New York
continues to be an ex officio member of the ARRC.
One commenter recommended that the currency element of the
definition of qualified rate in Sec. 1.1001-6(b)(3) of the Proposed
Regulations be removed. After stating that a qualified rate under the
Proposed Regulations must generally be a qualified floating rate, the
commenter reasoned that the currency requirement in the definition of
qualified rate is unnecessary because that requirement is already built
into the definition of qualified floating rate under Sec. 1.1275-5(b).
The Final Regulations do not adopt this comment because a qualified
rate under the Final Regulations is not required to be a qualified
floating rate. For example, an objective rate based on a qualified
floating rate may be described in Sec. 1.1001-6(h)(3)(ii)(D) of the
Final Regulations but not in Sec. 1.1001-6(h)(3)(ii)(A) of the Final
Regulations. Also, although the currency requirements in Sec. 1.1001-
6(h)(3)(i) of the Final Regulations and Sec. 1.1275-5(b) may overlap
in many cases, these requirements are not identical. The currency
requirement for qualified rates in the Final Regulations requires that
the discontinued IBOR and the interest rate benchmark included in the
qualified rate be based on the same currency, whereas the currency
requirement for qualified floating rates in Sec. 1.1275-5(b) requires
that the currency on which the qualified floating rate is based match
the currency in which the debt instrument is denominated.
The definition of qualified rate has also been amended in the Final
Regulations in response to public comments that identify gaps in how
the definition of qualified rate in the Proposed Regulations applies to
covered modifications that involve the addition or amendment of
fallback provisions. In particular, commenters asked how the definition
of qualified rate applies when a contract is modified to include a
waterfall of fallback rates, the individual tiers of which may not
independently satisfy the definition of qualified rate. Commenters also
asked how the definition of qualified rate applies to a fallback rate
that will be determined on the date that the fallback rate is triggered
and cannot be determined on the date of the modification by which that
fallback rate is added to the contract.
The Final Regulations address these comments by providing a series
of rules in sect; 1.1001-6(h)(3)(i) and (iii) for determining whether a
fallback rate or a collection of fallback rates meet the definition of
a qualified rate. Section 1.1001-6(h)(3)(i) of the Final Regulations
provides that a single qualified rate may be comprised of more than one
fallback rate, such as when the parties add a fallback waterfall. In
other words, this rule treats a waterfall of fallbacks as a unit and
evaluates that unit to determine if it is a qualified rate. Thus, if
the waterfall is designed so that each tier replaces the preceding tier
when triggered (for example, when USD LIBOR ceases, USD LIBOR is
replaced by the first tier of the waterfall and, if the first tier of
the waterfall ceases, that first tier is replaced by the second tier),
the entire waterfall is treated as a fallback to a discontinued IBOR
even though, as a technical matter, only the first tier of the
waterfall is a fallback to the discontinued IBOR. Section 1.1001-
6(h)(3)(iii)(A) of the Final Regulations generally provides that, when
a collection of fallback rates is added to the contract (for example, a
fallback waterfall), that collection of fallback rates is a qualified
rate only if each individual fallback rate in the collection meets the
requirements to be a qualified rate. Sections 1.1001-6(h)(3)(iii)(B)
and (C) of the Final Regulations apply for purposes of determining
whether an individual fallback rate (regardless of whether that
fallback rate was added to the contract individually or the fallback
rate was added as a collection of fallback rates and is being tested
individually under Sec. 1.1001-6(h)(3)(iii)(A) of the Final
Regulations) meets the requirements to be a qualified rate. Under Sec.
1.1001-6(h)(3)(iii)(B) of the Final Regulations, a fallback rate is
treated as not meeting the requirements to be a qualified rate if the
contractual terms that comprise the fallback rate do not ensure at the
time of the modification that the fallback rate will meet the
requirements to be a qualified rate identified in the first sentence of
Sec. 1.1001-6(h)(3)(i) of the Final Regulations when the fallback rate
is triggered. Under Sec. 1.1001-6(h)(3)(iii)(C) of the Final
Regulations, a fallback rate is treated as meeting the requirements to
be a qualified rate if the likelihood that it will ever be triggered is
remote. If Sec. 1.1001-6(h)(3)(iii)(B) and (C) of the Final
Regulations both apply to a given fallback rate, the rule in Sec.
1.1001-6(h)(3)(iii)(C) takes priority over the rule in Sec. 1.1001-
6(h)(3)(iii)(B). Examples in Sec. 1.1001-6(h)(3)(iv) of the Final
Regulations illustrate the operation of these rules for fallback rates.
d. Associated Modifications
The Proposed Regulations generally define an associated
modification as a modification that is both associated with the
replacement of an IBOR-based rate or the inclusion of fallbacks to an
IBOR-based rate and that is reasonably necessary to adopt or to
implement that replacement or inclusion. Section 1.1001-6(h)(5) of the
Final Regulations generally defines an associated modification
similarly but eliminates the requirement that an associated
modification be ``associated with'' such a replacement or inclusion
because any modification that is reasonably necessary to adopt or to
implement the replacement or inclusion is necessarily associated with
that replacement or inclusion.
The definition of ``associated modification'' in the Proposed
Regulations also includes a ``one-time payment,'' which is generally
defined as a payment to offset the change in value of the contract that
results from replacing an IBOR-based rate with a qualified rate. One
commenter asked whether certain cash payments can qualify as associated
modifications even if they do not qualify as one-time payments. For
example, if the parties to an interest rate swap agree to replace USD
LIBOR with a replacement rate comprised of a compounded average of SOFR
(computed in arrears using a two-day observation period shift without
payment lag) and a fixed adjustment spread, one party might also agree
to make an incidental cash payment to compensate the counterparty for
small valuation differences between the pre-
[[Page 170]]
modification LIBOR-based contract and the post-modification SOFR-based
contract, such as the valuation differences resulting from the
difference in observation period. The Treasury Department and the IRS
have concluded that including such limited payments within the
definition of an associated modification would further the policy goal
of the Final Regulations to facilitate the transition away from
discontinued IBORs. Accordingly, the definition of ``associated
modification'' in Sec. 1.1001-6(h)(5) of the Final Regulations
includes an incidental cash payment intended to compensate a
counterparty for small valuation differences resulting from a
modification of the administrative terms of a contract, such as the
valuation differences resulting from a change in observation period.
The Treasury Department and the IRS caution, however, that a payment of
an amount that is not incidental cannot qualify as an associated
modification.
e. Qualified One-Time Payments
The Proposed Regulations provide that a ``one-time payment,''
generally defined as a payment to offset the change in value of the
contract that results from replacing an IBOR-based rate with a
qualified rate, may be an associated modification. To improve
readability and clarity, the Final Regulations redesignate ``one-time
payments'' as ``qualified one-time payments'' and define the new term
in a standalone definition rather than as a kind of associated
modification.
Commenters asked whether the Proposed Regulations cap the amount of
a one-time payment and described certain abuses that may result if the
amount of the payment is not limited in some way. To clarify the intent
of the Proposed Regulations and to prevent excessive payments from
satisfying the definition of qualified one-time payments, the Final
Regulations generally limit a qualified one-time payment to the amount
intended to compensate for the basis difference between the
discontinued IBOR and the interest rate benchmark to which the
qualified rate refers. Any portion in excess of that cap is a
noncovered modification.
f. Fair Market Value Requirement and Excluded Modifications
The Proposed Regulations generally require that the fair market
value of the modified contract be substantially equivalent before and
after the modification. The Proposed Regulations provide two safe
harbors to the fair market value requirement: The historical average
safe harbor and the arm's length safe harbor. Under the historical
average safe harbor, the fair market value requirement is generally
satisfied if, on the date of the modification, the historical average
of the IBOR-based rate is within 25 basis points of the historical
average of the putative qualified rate. To qualify for the arm's length
safe harbor, the parties to the contract generally must not be related
under Sec. 267(b) or Sec. 707(b)(1), must conduct bona fide, arm's
length negotiations, and must determine based on those negotiations
that the fair market value requirement is satisfied. The Treasury
Department and the IRS received many public comments identifying
practical problems and technical issues with the fair market value
requirement and its two safe harbors. In response to these public
comments, the Treasury Department and the IRS have replaced the fair
market value requirement with rules that describe specific
modifications (the excluded modifications) and exclude those
modifications from the definition of covered modification. These
excluded modifications are described in Sec. 1.1001-6(j)(1) through
(5) of the Final Regulations.
One significant purpose of the fair market value requirement in the
Proposed Regulations is to ensure that the modifications to the cash
flows of an IBOR-referencing contract are intended to address the
replacement of the IBOR-based rate in the contract. Because the
excluded modifications replace the fair market value requirement, each
of the excluded modifications described in Sec. 1.1001-6(j)(1) through
(5) of the Final Regulations involves modifying the contract in a way
that changes the amount or timing of contractual cash flows.
In addition to a change in cash flows, each of the excluded
modifications also describes a particular purpose or intent of the
parties making the modification. Section 1.1001-6(j)(1) of the Final
Regulations generally describes a situation in which the parties to a
contract change the contractual cash flows to induce one or more of the
parties to perform any act necessary to consent to a covered
modification of the contract. Example 3 in Sec. 1.1001-6(j)(6)(iii)
illustrates the operation of Sec. 1.1001-6(j)(1). Section 1.1001-
6(j)(2) of the Final Regulations generally describes a situation in
which the parties to a contract agree to a contemporaneous noncovered
modification of that contract that does not necessarily change
contractual cash flows and, in consideration for that change, also
agree to change contractual cash flows. Example 5 in Sec. 1.1001-
6(j)(6)(v) illustrates the operation of Sec. 1.1001-6(j)(2). Section
1.1001-6(j)(3) of the Final Regulations generally describes a situation
in which one party to a contract is experiencing financial distress and
another party either makes a concession to or secures a concession from
the distressed party in the form of a change in contractual cash flows.
Example 6 in Sec. 1.1001-6(j)(6)(vi) illustrates the operation of
Sec. 1.1001-6(j)(3). Section 1.1001-6(j)(4) of the Final Regulations
generally describes a situation in which the parties to a contract
agree to change contractual cash flows on that contract as
consideration for some extra-contractual arrangement. Example 7 in
Sec. 1.1001-6(j)(6)(vii) illustrates the operation of Sec. 1.1001-
6(j)(4). Section 1.1001-6(j)(4) of the Final Regulations also includes
a special rule that applies when the parties make an aggregate
qualified one-time payment on a portfolio of modified contracts. In
that case, the portion of the qualified one-time payment allocable to
any one contract in the portfolio is treated as not intended to
compensate for any changes in rights or obligations under any other
contract in the portfolio.
In Sec. 1.1001-6(j)(5) of the Final Regulations, the Treasury
Department and the IRS reserve the authority to expand this list of
excluded modifications in guidance published in the Internal Revenue
Bulletin. To exercise this authority, the Treasury Department and the
IRS must conclude that the modification to be described in such
guidance has a principal purpose of achieving a result that is
unreasonable in light of the purpose of Sec. 1.1001-6. The Treasury
Department and the IRS have concluded that this reservation of
authority is necessary to prevent any unforeseen abuses of the
significant flexibility granted to taxpayers in the Final Regulations.
However, the Treasury Department and the IRS anticipate that any such
guidance would be prospective in effect.
g. Rev. Proc. 2020-44
In Rev. Proc. 2020-44, the Treasury Department and the IRS provided
rules that overlap with certain of the rules in the Final Regulations.
Like Sec. 1.1001-6(b)(1) of the Final Regulations, section 5.01 of
Rev. Proc. 2020-44 provides that a modification within the scope of the
revenue procedure is not treated as an exchange of property for other
property differing materially in kind or extent for purposes of Sec.
1.1001-1(a). And like Sec. 1.1001-6(c)(1)(iii) and (c)(2) of the Final
Regulations, section 5.02 of Rev. Proc. 2020-44 generally provides that
a modification within the scope of the
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revenue procedure will not result in legging out of an integrated
transaction or terminating either leg of a hedging transaction. Section
4.02 of Rev. Proc. 2020-44 generally limits the scope of the revenue
procedure to modifications to a contract to incorporate certain
fallback provisions published by the ARRC or ISDA, labeled the ``ARRC
Fallbacks'' and the ``ISDA Fallbacks'' by the revenue procedure. The
parties modifying a contract under Rev. Proc. 2020-44 may also deviate
in certain limited ways from the ARRC and ISDA Fallbacks. The Treasury
Department and the IRS noted that the scope of the revenue procedure
may be expanded in subsequent guidance published in the Internal
Revenue Bulletin to address developments in the transition away from
IBORs. The revenue procedure applies to modifications that occur on or
after October 9, 2020, and before January 1, 2023, although the parties
to a contract may rely on the revenue procedure for modifications that
occur before October 9, 2020.
In the definition of covered modification in Sec. 1.1001-6(h)(1),
the Final Regulations generally provide that a modification described
in section 4.02 of Rev. Proc. 2020-44 is treated as a covered
modification. A modification described in section 4.02 of Rev. Proc.
2020-44 is treated as a covered modification even if the revenue
procedure does not apply to that modification, for example, because the
modification occurs after the revenue procedure's sunset date of
December 31, 2022. The effect of this provision is that the rules in
Sec. Sec. 1.1001-6(b) through (g) and 1.860G-1(e), which rely on the
definition of covered modification in Sec. 1.1001-6(h)(1), apply to
modifications described in section 4.02 of Rev. Proc. 2020-44. Because
of the substantive overlap between the rules in Sec. 1.1001-6(b) and
(c) of the Final Regulations and the rules in section 5 of Rev. Proc.
2020-44, it is possible for a single modification to be subject to both
sets of rules. As a practical matter, however, the rules in Sec.
1.1001-6(b) and (c) of the Final Regulations are consistent with the
rules in section 5 of Rev. Proc. 2020-44, so no conflict is expected to
arise.
Prior to the release of Rev. Proc. 2020-44, several commenters
recommended that the Final Regulations accommodate the fallback
provisions published by the ARRC and ISDA. For example, one commenter
recommended that the Final Regulations provide that a modification to
incorporate the ARRC's or ISDA's fallback provisions or fallback
provisions substantially similar to the ARRC's or ISDA's fallback
provisions is not an exchange of property under section 1001. Rev.
Proc. 2020-44 and its incorporation into the definition of covered
modification in the Final Regulations address these comments.
2. Integrated Transactions and Hedging Transactions
Section 1.1001-6(c) of the Proposed Regulations generally provides
that the modification of a contract to replace an IBOR-based rate with
a qualified rate is not treated as legging out of a transaction
integrated under Sec. 1.1275-6, Sec. 1.988-5(a), or Sec. 1.148-4(h),
provided that the components of the transaction continue to qualify for
integration after the modification. That section also generally
provides that the modification of a contract to replace an IBOR-based
rate with a qualified rate is not treated as a disposition or
termination of either leg of a hedging transaction under Sec. 1.446-
4(e)(6). One commenter stated that, because Sec. 1.446-4 refers to
Sec. 1.1221-2(b) for the definition of ``hedging transaction'' and
because a hedging transaction and the hedged item must be identified as
provided in Sec. 1.1221-2(f), the inclusion in the Proposed
Regulations of a rule for Sec. 1.446-4 may justify a negative
inference that a similar rule is required to avoid reidentification
under Sec. 1.1221-2(f). The Treasury Department and the IRS have
concluded that Sec. 1.1001-6(b)(1) of the Final Regulations, which
provides that a covered modification of either a hedging transaction or
the hedged item is not treated as an exchange of property for other
property differing materially in kind or in extent for purposes of
Sec. 1.1001-1(a), is sufficient to ensure that neither the hedging
transaction nor the hedged item, as modified by the covered
modification, needs to be reidentified under Sec. 1.1221-2(f).
The same commenter noted that Sec. 1.1001-6(c) of the Proposed
Regulations does not include modifications to add or amend fallback
provisions and recommended that the Final Regulations clarify whether
the rules in that section apply to such modifications. The commenter
further stated that, if a debt instrument and a hedge that reference
the same ceasing IBOR are integrated under Sec. 1.1275-6 and the
parties' covered modifications of the two instruments result in the
fallback provisions being slightly mismatched either in timing (that
is, the fallbacks have slightly different triggers) or amount (that is,
the fallback rates are slightly different), that mismatch of the
fallback provisions could cause a leg out of the integrated transaction
even before either fallback provision is triggered. The commenter
recommended that such mismatched fallback provisions not cause a leg
out of an integrated transaction under Sec. 1.1275-6, Sec. 1.988-
5(a), or Sec. 1.148-4(h). In response to these comments, Sec. 1.1001-
6(c) of the Final Regulations applies to a covered modification, which
is generally defined to include the addition or amendment of fallback
provisions. Also, Sec. 1.1001-6(c)(2) of the Final Regulations
generally provides that a covered modification that adds or amends
fallback provisions is treated as not legging out of a transaction
integrated under Sec. 1.1275-6, Sec. 1.988-5(a), or Sec. 1.148-4(h).
The Treasury Department and the IRS caution, however, that any mismatch
in the fallback provisions of the components of a transaction
integrated under Sec. 1.1275-6, Sec. 1.988-5(a), or Sec. 1.148-4(h)
may result in legging out when one or more of those fallback provisions
are triggered. In that case, a taxpayer would first determine whether
the rules in Sec. 1.1001-6(c)(1) of the Final Regulations apply to any
modification that results from the triggered fallback provisions.
Several commenters raised questions about the Proposed Regulations'
requirement that, to avoid legging out under Sec. 1.1275-6, Sec.
1.988-5(a), or Sec. 1.148-4(h), the integrated hedge must continue to
qualify as a Sec. 1.1275-6 hedge, a Sec. 1.988-5(a) hedge, or a
qualified hedge, respectively, after the modification. Two commenters
asserted that certain minor mismatches between the modified terms of
the components will inevitably arise (either because of minor
differences in the modified terms or because the components are not
modified at the same time) and that such mismatches may prevent the
modified contracts from qualifying for continued integration under
Sec. 1.1001-6(c) of the Proposed Regulations. These commenters
recommended that, if under the Final Regulations a modification is not
treated as an exchange of property for purposes of section 1001, that
modification also not be treated as legging out of an integrated
transaction under Sec. 1.1275-6 or Sec. 1.988-5(a), regardless of
whether the modified contracts would otherwise continue to qualify for
integration. Alternatively, these commenters recommended that the Final
Regulations provide a grace period during which the modified components
of the integrated transaction do not have to meet the qualifications
for integration. The Final Regulations adopt these commenters'
alternative recommendation. Sections 1.1001-6(c)(1)(i), (ii), and (iv)
of the
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Final Regulations provide a grace period during which a covered
modification of a component of a transaction integrated under Sec.
1.1275-6, Sec. 1.988-5(a), or Sec. 1.148-4(h) does not result in
legging out of that integrated transaction, notwithstanding any
mismatch in timing or amount of payments that results from the covered
modification during the grace period. The grace period lasts 90 days
and starts on the date of the first covered modification of any
component of the integrated transaction. If, however, the hedge
component of the integrated transaction does not qualify as a Sec.
1.1275-6 hedge, a Sec. 1.988-5(a) hedge, or a qualified hedge under
Sec. 1.148-4(h), as appropriate, by the end of the grace period, the
covered modification is a legging out as of the date of the covered
modification.
These commenters also observed that taxpayers may enter into
temporary hedges, such as basis swaps, to manage the economic risk
posed by temporary mismatches between the terms of the components of a
transaction integrated under Sec. 1.1275-6 or Sec. 1.988-5(a). The
commenters recommended that the Final Regulations accommodate the
temporary integration of these hedges. The Final Regulations adopt this
comment and provide that temporary hedges entered into to mitigate the
economic effect of such temporary mismatches may be integrated during
the 90-day grace period without disruption to a transaction integrated
under Sec. 1.1275-6 or Sec. 1.988-5(a).
One commenter offered several comments that are specific to the
rules in the Proposed Regulations on integration of tax-advantaged
bonds under Sec. 1.148-4(h). This commenter recommended that the Final
Regulations clarify that the rules in Sec. 1.1001-6(c) for integration
of tax-advantaged bonds apply to a qualified hedge that is super-
integrated under Sec. 1.148-4(h)(4). Section 1.148-4(h)(4) generally
permits only negligible mismatches in timing and amount of payments on
super-integrated hedges and bonds, and super-integration of taxable-
index hedges, such as hedges based on IBORs, is even more strictly
limited. Accordingly, the Treasury Department and the IRS do not adopt
this comment, and the Final Regulations clarify that Sec. 1.1001-
6(c)(1)(iv) does not apply to hedges and bonds integrated under Sec.
1.148-4(h)(4).
This commenter also requested that the Final Regulations provide
that a one-time payment does not cause a hedge to fail to meet the
requirements for qualification under Sec. 1.148-4(h)(3)(iv)(C), as
required by Sec. 1.1001-6(c) of the Proposed Regulations. The
nonperiodic nature of a one-time payment could prevent qualification
under several of the requirements identified in Sec. 1.148-
4(h)(3)(iv)(C), such as the requirement that the contract contain no
significant investment element and the requirement that the payments on
the hedge correspond closely in time to the payments on the hedged
bonds. The Treasury Department and the IRS have determined that, in
each case, the obstacle to qualification can be eliminated by treating
the qualified one-time payment as a series of periodic payments spread
over time. Accordingly, Sec. 1.1001-6(c)(1)(iv) of the Final
Regulations provides that, solely for purposes of applying the
qualification requirements identified in Sec. 1.148-4(h)(3)(iv)(C), a
qualified one-time payment on the hedge or the hedged bonds is
allocated in a manner consistent with the way in which a termination
payment on a variable yield issue is allocated under Sec. 1.148-
4(h)(3)(iv)(H) and the qualification requirements under Sec. 1.148-
4(h)(3)(iv)(C) are applied as if the qualified one-time payment were a
series of periodic payments.
3. Fast-Pay Stock
Section 1.7701(l)-3 provides rules that prevent the avoidance of
tax by persons participating in fast-pay arrangements. A fast-pay
arrangement is defined in Sec. 1.7701(l)-3(b)(1) as any arrangement in
which a corporation has fast-pay stock outstanding for any part of its
taxable year. Fast-pay stock is defined in Sec. 1.7701(l)-3(b)(2)(i)
as stock structured so that dividends (as defined in section 316) paid
by the corporation with respect to the stock are economically (in whole
or in part) a return of the holder's investment (as opposed to only a
return on the holder's investment). Section 1.7701(l)-3(b)(2)(ii)
provides that the determination of whether stock is fast-pay stock is
based on all facts and circumstances. Stock is examined when it is
issued to determine if it is fast-pay stock and, ``for stock that is
not fast-pay stock when issued, when there is a significant
modification in the terms of the stock or the related agreements or a
significant change in the relevant facts and circumstances.'' Id.
One commenter stated that, in certain circumstances, a covered
modification of preferred stock could cause the stock to satisfy the
definition of fast-pay stock despite the fact that the parties modified
the stock not for the purpose of avoiding tax, but rather for the
purpose of addressing the discontinuation of an IBOR. Because stock is
re-examined to determine if it is fast-pay stock upon the occurrence of
either ``a significant modification in the terms of the stock or the
related agreements'' or ``a significant change in the relevant facts
and circumstances,'' the commenter recommended that the Final
Regulations provide that a covered modification is neither a
significant modification nor a significant change for this purpose.
The Treasury Department and the IRS have determined that such a
rule would further the purpose of the Final Regulations to facilitate
the transition away from IBORs that will be discontinued. In addition,
the scope and operation of the recommended rule are generally
consistent with the scope and operation of the rules in Sec. Sec.
1.1001-6(b)(1) and (d) of the Final Regulations (treatment of covered
modifications under section 1001 and under chapter 4, respectively).
Accordingly, the Final Regulations adopt this comment and provide in
Sec. 1.1001-6(e) that a covered modification of stock is not a
significant modification in the terms of the stock or the related
agreements or a significant change in the relevant facts and
circumstances for purposes of Sec. 1.7701(l)-3(b)(2)(ii). Unlike
Sec. Sec. 1.1001-6(b)(1) and (d) of the Final Regulations, however,
Sec. 1.1001-6(e) of the Final Regulations further provides that, if a
covered modification and a noncovered modification are made at the same
time or as part of the same plan and the noncovered modification is a
significant modification in the terms of the stock or the related
agreements or a significant change in the relevant facts and
circumstances, then Sec. 1.7701(l)-3(b)(2)(ii) applies and all of the
facts and circumstances, including the covered modification and the
noncovered modification, are considered in determining whether the
stock is fast-pay stock.
4. Investment Trusts Under Sec. 301.7701-4(c)(1)
Under Sec. 301.7701-4(c)(1), an investment trust is not classified
as a trust if there is a power under the trust agreement to vary the
investment of the certificate holders. One commenter recommended that a
covered modification of the income-apportioning terms of an ownership
interest be treated as not manifesting a power to vary the investment
of certificate holders in a trust under Sec. 301.7701-4(c)(1). The
Final Regulations adopt this comment, providing in Sec. 1.1001-6(f)
that neither a covered modification of a contract held by an investment
trust nor a covered modification of an ownership interest in the
investment trust manifest a power to
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vary the investment of the certificate holder for this purpose.
5. Rules Regarding Qualified One-Time Payments
The Proposed Regulations generally provide in Sec. 1.1001-6(d)
that the character and source of a one-time payment made by a given
payor is the same as the source and character of a payment under the
contract by that payor. For example, a one-time payment by a lessee on
a lease is characterized as a payment of rent and sourced accordingly.
The Treasury Department and the IRS received several comments
requesting clarification on how this rule applies to certain financial
contracts. Several commenters also requested clarification on the
timing of tax items associated with a one-time payment. One commenter
requested guidance on how a one-time payment is treated for purposes of
the arbitrage investment restrictions and private use restrictions that
apply to tax-advantaged bonds. The Treasury Department and the IRS are
still considering how best to address these issues relating to
qualified one-time payments. Until the Treasury Department and the IRS
publish further guidance, taxpayers may continue to rely on the rule in
Sec. 1.1001-6(d) of the Proposed Regulations to determine source and
character of a qualified one-time payment under the Final Regulations.
6. REMICs
Section 1.860G-1(e) of the Proposed Regulations provides special
rules applicable to REMICs that have issued interests with an IBOR-
based rate or that hold obligations with an IBOR-based rate. Section
1.860G-1(e)(4) of the Proposed Regulations provides certain rules
addressing the treatment of reasonable costs incurred to effect a
modification that qualifies for special treatment under Sec. 1.1001-
6(a)(1), (2), or (3) of the Proposed Regulations. One commenter noted
that the governing documents for a REMIC may require tax opinions and
rating agency confirmations in connection with the modifications
contemplated in the Proposed Regulations and recommended that the
Treasury Department and the IRS confirm that the costs of obtaining
these materials are ``reasonable costs'' within the meaning of Sec.
1.860G-1(e)(4) of the Proposed Regulations. Whether a cost is
reasonable depends upon the facts and circumstances relating both to
the nature of the cost and the amount of the cost. However, the
Treasury Department and the IRS generally agree that the costs of
obtaining tax opinions and rating agency confirmations required by the
governing documents for a REMIC are reasonable in nature.
7. Interest Expense of a Foreign Corporation
The Proposed Regulations provide in Sec. 1.882-5(d)(5)(ii)(B) that
a foreign corporation that is a bank may elect to compute interest
expense attributable to excess U.S.-connected liabilities using a
yearly average of SOFR. One commenter stated that a yearly average of
SOFR is not an equitable substitute for 30-day USD LIBOR, the rate that
foreign banks are permitted to elect for this purpose under the
existing regulations, because 30-day USD LIBOR is typically a higher
rate than a yearly average of SOFR. This commenter recommended that, in
lieu of SOFR, the Final Regulations either refer to a widely accepted
interest rate benchmark that is more similar than SOFR to 30-day USD
LIBOR or add a fixed adjustment spread to the yearly average of SOFR.
The Treasury Department and the IRS continue to study the
appropriate rate to replace 30-day USD LIBOR for purposes of the
published rate election under Sec. 1.882-5(d)(5)(ii)(B). In evaluating
the appropriate replacement rate, the Treasury Department and the IRS
will continue to balance the administrative convenience of providing
taxpayers an election to use the annual published rate with the need
for a replacement rate that more accurately reflects the taxpayer's
borrowing costs. In providing taxpayers with an election to use a
published rate, the Treasury Department and the IRS must ensure that
the replacement rate does not overstate the amount of interest expense
allocable to income that is effectively connected with the conduct of a
U.S. trade or business. Until final regulations are published that
replace the 30-day USD LIBOR election provided in Sec. 1.882-
5(d)(5)(ii)(B), taxpayers may continue to apply either the general rule
or the annual published rate election provided under Sec. 1.882-
5(d)(5)(ii) to calculate interest on excess U.S.-connected liabilities.
Taxpayers may also continue to rely on the rule in Sec. 1.882-
5(d)(5)(ii)(B) of the Proposed Regulations and compute interest on
excess U.S.-connected liabilities by computing a yearly average SOFR
based on the rates published by the Federal Bank of New York for the
taxable year. Although commenters provided some ideas on a rate that
could be closer to a replacement for 30-day LIBOR (for example, a
widely accepted interest rate benchmark or adding a fixed adjustment
spread to the yearly average of SOFR), the Treasury Department and the
IRS continue to request recommendations for a specific rate that would
be an appropriate replacement to 30-day LIBOR for computing interest
expense on excess U.S.-connected liabilities for purposes of Sec.
1.882-5(d)(5)(ii)(B). The Treasury Department and the IRS anticipate
issuing additional guidance addressing Sec. 1.882-5(d)(5)(ii)(B)
before 30-day USD LIBOR is discontinued in 2023.
8. Change of Accounting Method
One commenter asked the Treasury Department and the IRS to address
whether changing from an IBOR-based discount rate to a discount rate
based on a different interest rate benchmark for the purpose of valuing
securities under the mark-to-market rules in section 475 is a change in
method of accounting that requires the consent of the Secretary under
section 446(e). The commenter noted that this change may occur either
at the time when the relevant IBOR is discontinued or in advance of
that time in anticipation of the IBOR's discontinuation. To facilitate
an orderly transition in connection with the discontinuation of IBORs
and to treat changes from an IBOR-based discount rate in a consistent
manner, the Treasury Department and the IRS will not treat a change
from a discount rate that is based on a discontinued IBOR (as defined
in Sec. 1.1001-6(h)(4) of the Final Regulations) to a discount rate
that is a qualified rate for the purpose of valuing securities under
the mark-to-market rules in section 475 as a change in method of
accounting under section 446(e).
9. Applicability Dates
The Proposed Regulations under Sec. Sec. 1.860G-1(e), 1.1001-6,
and 1.1275-2(m) generally propose that the Final Regulations permit
taxpayers to apply the Final Regulations retroactively, as authorized
under section 7805(b)(7). However, the Proposed Regulations under Sec.
1.1001-6 propose that the Final Regulations require as a condition of a
taxpayer's retroactive application that all the taxpayer's related
parties also apply Sec. 1.1001-6 retroactively. One commenter
requested that this requirement be more clearly stated, and the Final
Regulations do so in Sec. 1.1001-6(k).
Another commenter observed that sections 267(b) and 707(b)(1),
under which relatedness is determined for purposes of the applicability
dates in the Proposed Regulations, do not effectively address
governmental entities or tax-exempt entities described in section
501(c)(3). This commenter recommended that relatedness be
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determined for such entities under Sec. 1.150-1(b) and (e). The
Treasury Department and the IRS agree with this comment and adopt the
commenter's recommendation in Sec. Sec. 1.1001-6(k) and 1.1275-2(m)(5)
of the Final Regulations.
Effect on Other Documents
Rev. Proc. 2020-44, 2020-45 I.R.B. 991, is amplified.
Special Analyses
I. Regulatory Planning and Review--Economic Analysis
Executive Orders 12866 and 13563 direct agencies to assess costs
and benefits of available regulatory alternatives and, if regulation is
necessary, to select regulatory approaches that maximize net benefits
(including (i) potential economic, environmental, and public health and
safety effects, (ii) potential distributive impacts, and (iii) equity).
Executive Order 13563 emphasizes the importance of quantifying both
costs and benefits, reducing costs, harmonizing rules, and promoting
flexibility.
These final regulations have been designated as subject to review
under Executive Order 12866 pursuant to the Memorandum of Agreement
(April 11, 2018) (MOA) between the Treasury Department and the Office
of Management and Budget (OMB) regarding review of tax regulations. The
Office of Information and Regulatory Affairs has designated these final
regulations as economically significant under section 1(c) of the MOA.
A. Background, Need for the Final Regulations, and Economic Analysis of
Final Regulations
A very large volume of U.S. financial products and contracts
include terms or conditions that reference LIBOR or, more generally,
IBORs. Concern about manipulation and a decline in the volume of the
funding from which LIBOR is calculated led to recommendations for the
development of alternatives to LIBOR that would be based on
transactions in a more robust underlying market. In addition, on July
27, 2017, the U.K. Financial Conduct Authority, the U.K. regulator
tasked with overseeing LIBOR, announced that all currency and term
variants of LIBOR, including USD LIBOR, may be phased out after 2021
and not be published after that timeframe. The administrator of LIBOR,
the ICE Benchmark Administration, announced on March 5, 2021, that
publication of overnight, one-month, three-month, six-month, and 12-
month USD LIBOR will cease immediately following the LIBOR publication
on June 30, 2023, and that publication of all other currency and tenor
variants of LIBOR will cease immediately following the LIBOR
publication on December 31, 2021.
The ARRC, a group of stakeholders affected by the cessation of the
publication of USD LIBOR, was convened to identify an alternative rate
and to facilitate voluntary adoption of that alternative rate. The ARRC
recommended SOFR as a potential replacement for USD LIBOR. Essentially
all financial products and contracts that currently contain conditions
or legal provisions that rely on LIBOR and other IBORs are expected to
transition to SOFR or similar alternatives in the next few years. This
transition will involve changes in debt, derivatives, and other
financial contracts to adopt SOFR or other alternative reference rates.
The ARRC has estimated that the total exposure to USD LIBOR was close
to $200 trillion in 2016, of which approximately 95 percent were in
over-the-counter derivatives. ARRC further notes that USD LIBOR is also
referenced in several trillion dollars of corporate loans, floating-
rate mortgages, and similar financial products. In the absence of
further tax guidance, the vast majority of expected changes in such
contracts could lead to the recognition of gains (or losses) in these
contracts for U.S. income tax purposes and to correspondingly
potentially large tax liabilities for their holders. To address this
issue, the final regulations provide that changes in debt instruments,
derivative contracts, and other affected contracts to replace reference
rates based on discontinued IBORs in a covered modification (both as
defined in the final regulations) will not result in tax realization
events under section 1001 and relevant regulations thereunder. For this
purpose, a covered modification is generally the replacement of a
discontinued IBOR with a qualified rate, provided that the replacement
is not excluded under Sec. 1.1001-6(j)(1) through (5) of these final
regulations (the excluded modifications). The excluded modifications
ensure that a covered modification includes only modifications to the
cash flows of an IBOR-referencing contract intended to address the
replacement of the IBOR-based rate in the contract and that
modifications of contracts in a manner that is intended to change the
amount or timing of contractual cash flows for other reasons or
purposes remain subject to the general rules in section 1001 and the
regulations thereunder. The final regulations also provide
corresponding guidance on hedging transactions and derivatives to the
effect that taxpayers may modify the components of hedged or integrated
transactions to replace discontinued IBORs in a covered modification
without affecting the tax treatment of the hedges or underlying
transactions.
In the absence of these final regulations, parties to contracts
affected by the cessation of the publication of LIBOR would either
suffer tax consequences to the extent that a change to the contract
results in a tax realization event under section 1001 or attempt to
find alternative contracts that avoid such a tax realization event,
which may be difficult as a commercial matter. Both such options would
be both costly and highly disruptive to U.S. financial markets. A large
number of contracts may end up being breached, which may lead to
bankruptcies or other legal proceedings. The types of actions that
contract holders might take in the absence of these final regulations
are difficult to predict because such an event is outside recent
experience in U.S. financial markets. This financial disruption would
be particularly unproductive because the economic characteristics of
the financial products and contracts under the new rates would be
essentially unchanged. Thus, there is no underlying economic rationale
for a tax realization event.
The Treasury Department and the IRS project that these final
regulations would avoid this costly and unproductive disruption. The
Treasury Department and the IRS further project that these final
regulations, by implementing the regulatory provisions requested by
ARRC and taxpayers, will help facilitate the economy's adaptation to
the cessation of LIBOR in a least-cost manner.
II. Regulatory Flexibility Act
It is hereby certified that the Final Regulations will not have a
significant economic impact on a substantial number of small entities
within the meaning of section 601(6) of the Regulatory Flexibility Act
(5 U.S.C. chapter 6).
As discussed elsewhere in this preamble, the administrator of all
currency and tenor variants of LIBOR has announced that publication of
overnight, one-month, three-month, six-month, and 12-month USD LIBOR
will cease on June 30, 2023, and that publication of all other currency
and tenor variants of LIBOR will cease on December 31, 2021. Many
contracts, including financial contracts such as debt instruments and
derivative contracts, refer to LIBOR or another IBOR to determine the
parties' rights
[[Page 175]]
and obligations under the contract. When parties to IBOR-referencing
contracts modify those contracts in anticipation of the discontinuation
of the referenced IBOR, that modification can be a tax realization
event, giving rise to gain, loss, income, or deduction. That
modification can also cause other unintended tax consequences.
The number of small entities potentially affected by the Final
Regulations is unknown but could be substantial because entities of all
sizes are parties to contracts that reference a discontinued IBOR.
Although a substantial number of small entities is potentially affected
by the Final Regulations, the Treasury Department and the IRS have
concluded that the Final Regulations will not have a significant
economic impact on a substantial number of small entities. This is
because the purpose and effect of the Final Regulations is to minimize
the economic impact of the transition away from LIBOR and other
discontinued IBORs by preventing many of the tax consequences that
might otherwise flow when taxpayers modify IBOR-referencing contracts
in anticipation of the cessation of a discontinued IBOR. Furthermore,
the Final Regulations do not impose a collection of information on any
taxpayers, including small entities. Accordingly, the Final Regulations
will not have a significant economic impact on a substantial number of
small entities.
III. Unfunded Mandates Reform Act
Section 202 of the Unfunded Mandates Reform Act of 1995 requires
that agencies assess anticipated costs and benefits and take certain
other actions before issuing a final rule that includes any Federal
mandate that may result in expenditures in any one year by a state,
local, or tribal government, in the aggregate, or by the private
sector, of $100 million in 1995 dollars, updated annually for
inflation. The Final Regulations do not include any Federal mandate
that may result in expenditures by state, local, or tribal governments,
or by the private sector in excess of that threshold.
IV. Executive Order 13132: Federalism
Executive Order 13132 (entitled ``Federalism'') prohibits an agency
from publishing any rule that has federalism implications if the rule
either imposes substantial, direct compliance costs on state and local
governments, and is not required by statute, or preempts state law,
unless the agency meets the consultation and funding requirements of
section 6 of the Executive Order. The Final Regulations do not have
federalism implications and do not impose substantial direct compliance
costs on state and local governments or preempt state law within the
meaning of the Executive Order.
V. Congressional Review Act
The Administrator of the Office of Information and Regulatory
Affairs of the OMB has determined that this Treasury decision is a
major rule for purposes of the Congressional Review Act (5 U.S.C. 801
et seq.) (``CRA''). Under section 801(3) of the CRA, a major rule takes
effect 60 days after the rule is published in the Federal Register.
Accordingly, the Treasury Department and IRS are adopting the Final
Regulations with the delayed effective date generally prescribed under
the Congressional Review Act.
Drafting Information
The principal authors of these final regulations are Caitlin Holzem
and Spence Hanemann of the Office of Associate Chief Counsel (Financial
Institutions and Products). However, other personnel from the Treasury
Department and the IRS participated in their development.
Availability of IRS Documents
The revenue procedure cited in this preamble is published in the
Internal Revenue Bulletin (or Cumulative Bulletin) and is available
from the Superintendent of Documents, U.S. Government Publishing
Office, Washington, DC 20402, or by visiting the IRS website at <a href="https://www.irs.gov">https://www.irs.gov</a>.
List of Subjects
26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
26 CFR Part 301
Employment taxes, Estate taxes, Excise taxes, Gift taxes, Income
taxes, Penalties, Reporting and recordkeeping requirements.
Adoption of Amendments to the Regulations
Accordingly, 26 CFR parts 1 and 301 are amended as follows:
PART 1--INCOME TAXES
0
Paragraph 1. The authority citation for part 1 is amended by revising
the entry for Sec. 1.860G-1 and adding an entry in numerical order for
Sec. 1.1001-6 to read in part as follows:
Authority: 26 U.S.C. 7805 * * *
Section 1.860G-1 also issued under 26 U.S.C. 860G(a)(1)(B),
(d)(2)(E), and (e).
* * * * *
Section 1.1001-6 also issued under 26 U.S.C. 148(i), 26 U.S.C.
988(d), 26 U.S.C. 1275(d), and 26 U.S.C. 7701(l).
* * * * *
0
Par. 2. Section 1.860A-0 is amended by adding entries for Sec. 1.860A-
1(b)(6) and (7) and Sec. 1.860G-1(e) to read as follows:
Sec. 1.860A-0 Outline of REMIC provisions.
* * * * *
Sec. 1.860A1-1 Effective dates and transition rules.
* * * * *
(b) * * *
(6) Exceptions for certain modified obligations.
(7) Exceptions for certain modifications of obligations that refer
to certain interbank offered rates.
* * * * *
Sec. 1.860G1 1 Definition of regular and residual interests.
* * * * *
(e) Transition from certain interbank offered rates.
(1) In general.
(2) Change in reference rate for a regular interest after the
startup day.
(3) Contingencies of rate on a regular interest.
(4) Reasonable expenses incurred to make covered modifications.
* * * * *
0
Par. 3. Section 1.860A-1 is amended by adding paragraph (b)(7) to read
as follows:
Sec. 1.860A1 -1 Effective dates and transition rules.
* * * * *
(b) * * *
(7) Exceptions for certain modifications of obligations that refer
to certain interbank offered rates--(i) Paragraphs (e)(2) and (4) of
Sec. 1.860G-1 apply with respect to a covered modification that occurs
on or after March 7, 2022. However, paragraphs (e)(2) and (4) of Sec.
1.860G-1 may be applied with respect to a covered modification that
occurs before March 7, 2022. See section 7805(b)(7).
(ii) Paragraph (e)(3) of Sec. 1.860G-1 applies to a regular
interest in a REMIC issued on or after March 7, 2022. However,
paragraph (e)(3) of Sec. 1.860G-1 may be applied to a regular interest
in a REMIC issued before March 7, 2022. See section 7805(b)(7).
0
Par. 4. Section 1.860G-1 is amended by:
[[Page 176]]
0
1. Removing ``paragraph (b)(3)'' in paragraph (a)(5) and adding in its
place ``paragraphs (b)(3) and (e)(4)''.
0
2. Adding paragraph (e).
The addition reads as follows:
Sec. 1.860G1-1 Definition of regular and residual interests.
* * * * *
(e) Transition from certain interbank offered rates--(1) In
general. This paragraph (e) provides rules relating to the modification
of the terms of a regular interest in a REMIC or the terms of an asset
held by a REMIC as part of the transition away from the London
Interbank Offered Rate and certain other interbank offered rates. For
purposes of this paragraph (e), covered modification and discontinued
IBOR have the meanings provided in Sec. 1.1001-6(h)(1) and (4),
respectively. See Sec. 1.1001-6 for additional rules that may apply to
an interest in a REMIC that provides for a rate referencing a
discontinued IBOR.
(2) Change in reference rate for a regular interest after the
startup day. A covered modification of a regular interest in a REMIC
that occurs after the startup day is disregarded in determining whether
the modified regular interest has fixed terms on the startup day under
paragraph (a)(4) of this section.
(3) Contingencies of rate on a regular interest. An interest in a
REMIC does not fail to qualify as a regular interest solely because it
is subject to a contingency whereby a rate that references a
discontinued IBOR and is a variable rate permitted under paragraph
(a)(3) of this section may change to a fixed rate or a different
variable rate permitted under paragraph (a)(3) of this section in
anticipation of the discontinued IBOR becoming unavailable or
unreliable.
(4) Reasonable expenses incurred to make covered modifications. An
interest in a REMIC does not fail to qualify as a regular interest
solely because it is subject to a contingency whereby the amount of
payments of principal or interest (or other similar amounts) with
respect to the interest in the REMIC is reduced by reasonable costs
incurred to effect a covered modification. In addition, payment by a
party other than the REMIC of reasonable costs incurred to effect a
covered modification is not a contribution to the REMIC for purposes of
section 860G(d).
0
Par. 5. Section 1.1001-6 is added to read as follows:
Sec. 1.10011-6 Transition from certain interbank offered rates.
(a) In general. This section provides rules relating to the
modification of the terms of a contract as part of the transition away
from the London Interbank Offered Rate and certain other interbank
offered rates. In general, paragraphs (b) through (g) of this section
provide the operative rules for a covered modification. Paragraph (h)
of this section defines certain terms that are used in these operative
rules, such as covered modification, qualified rate, discontinued IBOR,
associated modification, and qualified one-time payment. Paragraph (j)
of this section describes certain modifications that are not covered
modifications and provides examples that illustrate the operation of
the rules in paragraph (j) of this section. For rules regarding
original issue discount on certain debt instruments that provide for a
rate referencing a discontinued IBOR, see Sec. 1.1275-2(m). For rules
regarding certain interests in a REMIC that provide for a rate
referencing a discontinued IBOR, see Sec. 1.860G-1(e).
(b) Treatment under section 1001--(1) Covered modifications. A
covered modification of a contract is not treated as the exchange of
property for other property differing materially in kind or in extent
for purposes of Sec. 1.1001-1(a). For example, if the terms of a debt
instrument that pays interest at a rate referencing the U.S.-dollar
London Interbank Offered Rate (USD LIBOR) are modified to provide that
the debt instrument pays interest at a qualified rate referencing the
Secured Overnight Financing Rate published by the Federal Reserve Bank
of New York (SOFR) and the modification is not described in paragraph
(j) of this section, the modification is not treated as the exchange of
property for other property differing materially in kind or in extent
for purposes of Sec. 1.1001-1(a).
(2) Contemporaneous noncovered modifications. If a covered
modification is made at the same time as a noncovered modification,
Sec. 1.1001-1(a) or Sec. 1.1001-3, as appropriate, applies to
determine whether the noncovered modification results in the exchange
of property for other property differing materially in kind or in
extent. In applying Sec. 1.1001-1(a) or Sec. 1.1001-3 for this
purpose, the covered modification is treated as part of the terms of
the contract prior to the noncovered modification. For example, if the
parties to a debt instrument modify the interest rate in a manner that
is a covered modification and contemporaneously extend the final
maturity date of the debt instrument, which is a noncovered
modification, only the extension of the final maturity date is analyzed
under Sec. 1.1001-3 and, for purposes of that analysis, the modified
interest rate is treated as a term of the instrument prior to the
extension of the final maturity date.
(c) Effect of a covered modification on integrated transactions and
hedging transactions--(1) In general. Except as otherwise provided in
paragraph (c)(2) of this section, the rules in paragraphs (c)(1)(i)
through (iv) of this section determine the effect of a covered
modification on an integrated transaction under Sec. 1.1275-6, a
qualified hedging transaction under Sec. 1.988-5(a), a hedging
transaction under Sec. 1.446-4, or a qualified hedging transaction
under Sec. 1.148-4(h).
(i) A covered modification of one or more contracts that are part
of an integrated transaction under Sec. 1.1275-6 is treated as not
legging out of the integrated transaction, provided that, no later than
the end of the 90-day period beginning on the date of the first covered
modification of any such contract, the financial instrument that
results from any such covered modifications satisfies the requirements
to be a Sec. 1.1275-6 hedge (as defined in Sec. 1.1275-6(b)(2)) with
respect to the qualifying debt instrument that results from any such
covered modification. If a taxpayer enters into a financial instrument
intended to mitigate the economic effect of a temporary mismatch of the
legs of the integrated transaction during that 90-day period (a Sec.
1.1275-6 interim hedge), the integration of the Sec. 1.1275-6 interim
hedge with the other components of the integrated transaction during
the 90-day period is treated as not legging into a new integrated
transaction and the termination of the Sec. 1.1275-6 interim hedge
before the end of the 90-day period is treated as not legging out of
the existing integrated transaction.
(ii) A covered modification of one or more contracts that are part
of a qualified hedging transaction under Sec. 1.988-5(a) is treated as
not legging out of the qualified hedging transaction, provided that, no
later than the end of the 90-day period beginning on the date of the
first covered modification of any such contract, the financial
instrument or series or combination of financial instruments that
results from any such covered modifications satisfies the requirements
to be a Sec. 1.988-5(a) hedge (as defined in Sec. 1.988-5(a)(4)) with
respect to the qualifying debt instrument that results from any such
covered modification. If a taxpayer enters into a financial instrument
intended to mitigate the economic effect of a temporary mismatch of the
legs of the qualified hedging transaction during that 90-day period (a
Sec. 1.988-5(a) interim hedge), the integration of the
[[Page 177]]
Sec. 1.988-5(a) interim hedge with the other components of the
qualified hedging transaction during the 90-day period is treated as
not legging into a new qualified hedging transaction and the
termination of the Sec. 1.988-5(a) interim hedge before the end of the
90-day period is treated as not legging out of the existing qualified
hedging transaction.
(iii) A covered modification of one leg of a transaction subject to
the hedge accounting rules in Sec. 1.446-4 is not treated as a
disposition or termination (within the meaning of Sec. 1.446-4(e)(6))
of either leg of the transaction.
(iv) A covered modification of a qualified hedge or of the tax-
advantaged bonds with which the qualified hedge is integrated under
Sec. 1.148-4(h)(1) is treated as not terminating the qualified hedge
under Sec. 1.148-4(h)(3)(iv)(B), provided that, no later than the end
of the 90-day period beginning on the date of the first covered
modification of either the qualified hedge or the hedged bonds, the
qualified hedge that results from any such covered modification
satisfies the requirements to be a qualified hedge (determined by
applying the special rules for certain modifications of qualified
hedges under Sec. 1.148-4(h)(3)(iv)(C)) with respect to the hedged
bonds that result from any such covered modification. Solely for
purposes of determining whether the qualified hedge that results from a
covered modification satisfies the requirements to be a qualified hedge
with respect to the hedged bonds that result from any such covered
modification in the preceding sentence, a qualified one-time payment
with respect to the hedge or the hedged bonds (or both) is allocated in
a manner consistent with the allocation of a termination payment for a
variable yield issue under Sec. 1.148-4(h)(3)(iv)(H) and treated as a
series of periodic payments. This paragraph (c)(1)(iv) does not apply
if, prior to any covered modifications, the qualified hedge and the
tax-advantaged bond are integrated under Sec. 1.148-4(h)(4).
(2) Fallback rates. If a covered modification of a contract that is
part of an integrated transaction under Sec. 1.1275-6 is described in
paragraph (h)(1)(ii) or (iii) of this section, that covered
modification is treated as not legging out of the integrated
transaction. If a covered modification of a contract that is part of a
qualified hedging transaction under Sec. 1.988-5(a) is described in
paragraph (h)(1)(ii) or (iii) of this section, that covered
modification is treated as not legging out of the qualified hedging
transaction. If a covered modification of a qualified hedge or of the
tax-advantaged bonds with which the qualified hedge is integrated under
Sec. 1.148-4(h) is described in paragraph (h)(1)(ii) or (iii) of this
section, that covered modification is treated as not terminating the
qualified hedge under Sec. 1.148-4(h)(3)(iv)(B).
(d) Coordination with provision for existing obligations under
chapter 4. A modification of a contract is not a material modification
of that contract for purposes of Sec. 1.1471-2(b)(2)(iv) to the extent
the modification is a covered modification. See paragraph (b)(2) of
this section for rules that apply for purposes of Sec. 1.1471-
2(b)(2)(iv) when a modification to a contract includes both a covered
modification and a contemporaneous noncovered modification.
(e) Coordination with fast-pay stock rules. A covered modification
of stock is not a significant modification in the terms of the stock or
the related agreements or a significant change in the relevant facts
and circumstances for purposes of Sec. 1.7701(l)-3(b)(2)(ii). If a
covered modification is made at the same time as, or as part of a plan
that includes, a noncovered modification and the noncovered
modification is a significant modification in the terms of the stock or
the related agreements or a significant change in the relevant facts
and circumstances, then Sec. 1.7701(l)-3(b)(2)(ii) applies to
determine whether the stock is fast-pay stock, taking into account all
the facts and circumstances (including both the covered and noncovered
modification).
(f) Coordination with rules for investment trusts. A covered
modification of a contract held by an investment trust does not
manifest a power to vary the investment of the certificate holders for
purposes of Sec. 301.7701-4(c)(1) of this chapter. Further, a covered
modification of an ownership interest in an investment trust does not
manifest a power to vary the investment of the certificate holder for
purposes of Sec. 301.7701-4(c)(1) of this chapter.
(g) [Reserved]
(h) Definitions--(1) Covered modification. A covered modification
is a modification or portion of a modification of the terms of a
contract that is described in one or more of paragraphs (h)(1)(i)
through (iii) of this section and that is not described in any of
paragraphs (j)(1) through (5) of this section. Any modification of the
terms of a contract described in section 4.02 of Rev. Proc. 2020-44,
2020-45 I.R.B. 991, or described in other guidance published in the
Internal Revenue Bulletin that supplements the list of modifications
described in section 4.02 of Rev. Proc. 2020-44 or the definitions on
which that section relies (see Sec. 601.601(d)(2)(ii)(a) of this
chapter) is treated as a covered modification. For purposes of this
section, a modification of the terms of a contract includes any
modification of the terms of the contract, regardless of the form of
the modification (for example, a modification may be an exchange of one
contract for another, an amendment to the existing contract, or a
modification accomplished indirectly through one or more transactions
with third parties) and regardless of whether the modification is
evidenced by an express agreement (oral or written), conduct of the
parties, or otherwise. For purposes of this section, a contract
includes but is not limited to a debt instrument, a derivative
contract, stock, an insurance contract, and a lease agreement.
(i) The terms of the contract are modified to replace an operative
rate that references a discontinued IBOR with a qualified rate, to add
an obligation for one party to make a qualified one-time payment (if
any), and to make associated modifications (if any).
(ii) The terms of the contract are modified to include a qualified
rate as a fallback to an operative rate that references a discontinued
IBOR and to make associated modifications (if any).
(iii) The terms of the contract are modified to replace a fallback
rate that references a discontinued IBOR with a qualified rate and to
make associated modifications (if any).
(2) Noncovered modification. A noncovered modification is any
modification or portion of a modification of the terms of a contract
that is not a covered modification.
(3) Qualified rate--(i) In general. A qualified rate is any of the
rates described in paragraph (h)(3)(ii) of this section, provided that
the interest rate benchmark to which the rate refers and the
discontinued IBOR identified in paragraph (h)(1)(i), (ii), or (iii) of
this section are based on transactions conducted in the same currency
or are otherwise reasonably expected to measure contemporaneous
variations in the cost of newly borrowed funds in the same currency.
For purposes of paragraphs (h)(1)(ii) and (iii) of this section, a
single qualified rate may be comprised of one or more fallback rates
(for example, a waterfall of fallback rates). Paragraph (h)(3)(iii) of
this section provides additional rules for determining whether one or
more fallback rates constitute a qualified rate, and paragraph
(h)(3)(iv) of this section
[[Page 178]]
provides examples illustrating the operation of those rules.
(ii) Rates. The following rates are described in this paragraph
(h)(3)(ii):
(A) A qualified floating rate, as defined in Sec. 1.1275-5(b), but
without regard to the limitations on multiples set forth in Sec.
1.1275-5(b) (examples of qualified floating rates generally include
SOFR, the Sterling Overnight Index Average, the Tokyo Overnight Average
Rate, the Swiss Average Rate Overnight, and the euro short-term rate
administered by the European Central Bank);
(B) An alternative, substitute, or successor rate selected,
endorsed, or recommended by the central bank, reserve bank, monetary
authority, or similar institution (including any committee or working
group thereof) as a replacement for a discontinued IBOR or its local
currency equivalent in that jurisdiction;
(C) A rate selected, endorsed, or recommended by the Alternative
Reference Rates Committee as a replacement for USD LIBOR, provided that
the Federal Reserve Bank of New York is an ex officio member of the
Alternative Reference Rates Committee at the time of the selection,
endorsement, or recommendation;
(D) A rate that is determined by reference to a rate described in
paragraph (h)(3)(ii)(A), (B), or (C) of this section, including a rate
determined by adding or subtracting a specified number of basis points
to or from the rate or by multiplying the rate by a specified number;
and
(E) A rate identified for purposes of this section as a qualified
rate in guidance published in the Internal Revenue Bulletin (see Sec.
601.601(d)(2)(ii)(a) of this chapter).
(iii) Rules for fallback rates--(A) Multiple fallback rates. If the
rate being tested as a qualified rate is comprised of more than one
fallback rate, the rate is a qualified rate only if each individual
fallback rate separately satisfies the requirements to be a qualified
rate.
(B) Indeterminable fallback rate. Except as provided in paragraph
(h)(3)(iii)(C) of this section, if it is not possible to determine at
the time of the modification being tested as a covered modification
whether a fallback rate satisfies the requirements set forth in the
first sentence of paragraph (h)(3)(i) of this section (for example, the
calculation agent will determine the fallback rate at the time that the
fallback rate is triggered based on factors that are not guaranteed to
produce a rate described in paragraph (h)(3)(ii) of this section), the
fallback rate is treated as not satisfying the requirements to be a
qualified rate.
(C) Fallback rate is a remote contingency. If the likelihood that
any value will ever be determined under the contract by reference to a
fallback rate is remote (determined at the time of the modification
being tested as a covered modification), that fallback rate is treated
as satisfying the requirements to be a qualified rate.
(iv) Examples. The following examples illustrate the application of
the rules in paragraphs (h)(3)(i) through (iii) of this section to
qualified rates comprised of one or more fallback rates.
(A) Example 1: Addition of a single fallback rate--(1) Facts. B is
the issuer and L is the holder of a debt instrument that pays interest
semiannually in U.S. dollars at a rate of six-month USD LIBOR and that
contains no fallback provisions to address the pending discontinuation
of six-month USD LIBOR. On July 1, 2022, B and L modify the debt
instrument to add such fallback provisions (the new fallbacks). The new
fallbacks provide that, upon the discontinuation of six-month USD
LIBOR, six-month USD LIBOR will be replaced by a fallback rate equal to
CME Group's forward-looking SOFR term rate of a six-month tenor (six-
month CME Term SOFR) plus a fixed spread that will be determined at the
time of six-month USD LIBOR's discontinuation. Six-month USD LIBOR will
be discontinued on June 30, 2023.
(2) Analysis. The fallback rate is a qualified floating rate and
is, therefore, described in paragraph (h)(3)(ii)(A) of this section.
Moreover, because both six-month USD LIBOR and six-month CME Term SOFR
are based on transactions conducted in U.S. dollars, the fallback rate
satisfies the currency requirement in paragraph (h)(3)(i) of this
section. As further provided in paragraph (h)(3)(i) of this section, B
and L must also apply the rules in paragraph (h)(3)(iii)(A), (B), and
(C) of this section to determine if the fallback rate is a qualified
rate. Because the rate being tested as a qualified rate (i.e., the
fallback rate) is comprised of only one fallback rate, paragraph
(h)(3)(iii)(A) of this section has no effect. As discussed elsewhere in
this paragraph (h)(3)(iv)(A)(2), it is evident at the time of the
fallback rate's addition that the fallback rate satisfies the
requirements set forth in the first sentence of paragraph (h)(3)(i) of
this section, so paragraph (h)(3)(iii)(B) of this section has no
effect. Because it appears likely at the time of the modification that
the fallback rate will be used to determine interest on the debt
instrument, paragraph (h)(3)(iii)(C) of this section has no effect. In
summary, the fallback rate is described in paragraph (h)(3)(ii)(A) of
this section and satisfies the currency requirement in paragraph
(h)(3)(i) of this section, and none of the rules in paragraph
(h)(3)(iii) of this section affect the analysis. Therefore, the
fallback rate is a qualified rate.
(B) Example 2: Addition of a single indeterminable fallback rate--
(1) Facts. The facts are the same as in paragraph (h)(3)(iv)(A)(1) of
this section (Example 1), except that the new fallbacks provide that,
upon the discontinuation of six-month USD LIBOR, B will select a
replacement for six-month USD LIBOR based on the industry standard at
the time of selection.
(2) Analysis. As provided in paragraph (h)(3)(i) of this section, B
and L must apply the rule in paragraph (h)(3)(iii)(B) of this section
to determine whether the fallback rate is a qualified rate. Because it
is not possible to determine at the time of the fallback rate's
addition in 2022 whether the fallback rate (i.e., the replacement rate
that B will select in 2023) satisfies the requirements set forth in the
first sentence of paragraph (h)(3)(i) of this section, the fallback
rate is treated as not satisfying the requirements to be a qualified
rate under paragraph (h)(3)(iii)(B) of this section. Therefore, the
fallback rate is not a qualified rate.
(C) Example 3: Addition of a fallback waterfall that is a qualified
rate--(1) Facts. The facts are the same as in paragraph
(h)(3)(iv)(A)(1) of this section (Example 1), except that the new
fallbacks provide for a fallback waterfall. The first tier of the
fallback waterfall provides that, upon the discontinuation of six-month
USD LIBOR, six-month USD LIBOR will be replaced by a fallback rate
equal to six-month CME Term SOFR plus a fixed spread that will be
determined at the time of six-month USD LIBOR's discontinuation. The
second tier of the fallback waterfall provides that, upon the
discontinuation of six-month CME Term SOFR, B will select a replacement
for the fallback rate in the first tier of the fallback waterfall based
on the industry standard at the time of selection. At the time of the
fallback waterfall's addition, the likelihood that six-month CME Term
SOFR will be discontinued is remote.
(2) Analysis of the fallback waterfall. As provided in paragraph
(h)(3)(i) of this section, B and L must apply the rules in paragraphs
(h)(3)(iii)(A), (B) and (C) of this section to determine whether the
fallback waterfall is a qualified rate. Under paragraph (h)(3)(iii)(A)
of this section, because the rate being tested as a qualified rate
(i.e., the fallback waterfall) is comprised of more than one
[[Page 179]]
fallback rate, the fallback waterfall is a qualified rate only if each
individual fallback rate (i.e., fallback rates in the first and second
tiers of the fallback waterfall) separately satisfies the requirements
to be a qualified rate. As concluded in paragraphs (h)(3)(iv)(C)(3) and
(4) of this section, the fallback rates in the first and second tiers
of the fallback waterfall separately satisfy the requirements to be a
qualified rate. Therefore, the fallback waterfall is a qualified rate.
(3) Analysis of the first tier of the fallback waterfall. Because
the fallback rate in the first tier of the fallback waterfall is the
same as the fallback rate in paragraph (h)(3)(iv)(A)(1) of this section
(Example 1), the analysis of the fallback rate in the first tier of the
fallback waterfall is the same as the analysis of the fallback rate in
paragraph (h)(3)(iv)(A)(2) of this section (Example 1). Accordingly,
the fallback rate in the first tier of the fallback waterfall
separately satisfies the requirements to be a qualified rate.
(4) Analysis of the second tier of the fallback waterfall. The
fallback rate in the second tier of the fallback waterfall is the same
as the fallback rate in paragraph (h)(3)(iv)(B)(1) of this section
(Example 2). However, unlike the fallback rate in paragraph
(h)(3)(iv)(B)(1) of this section (Example 2), the likelihood that the
amount of interest on the debt instrument will ever be determined by
reference to the fallback rate in the second tier of the fallback
waterfall is remote. Accordingly, under paragraph (h)(3)(iii)(C) of
this section, the fallback rate in the second tier of the fallback
waterfall is treated as satisfying the requirements to be a qualified
rate.
(D) Example 4: Addition of a fallback waterfall that is not a
qualified rate--(1) Facts. The facts are the same as in paragraph
(h)(3)(iv)(A)(1) of this section (Example 1), except that the new
fallbacks provide for a fallback waterfall. The first tier of the
fallback waterfall provides that, upon the discontinuation of six-month
USD LIBOR, six-month USD LIBOR will be replaced by a stated fallback
rate (Fallback Rate X). Fallback Rate X, which is equal to an interest
rate benchmark (Benchmark X) plus a fixed spread, satisfies the
requirements set forth in the first sentence of paragraph (h)(3)(i) of
this section. The second tier of the fallback waterfall provides that,
upon the discontinuation of Benchmark X, B will select a replacement
for Fallback Rate X based on the industry standard at the time of
selection. At the time of the fallback waterfall's addition, the
likelihood that Benchmark X will be discontinued is not remote.
(2) Analysis of the fallback waterfall. As provided in paragraph
(h)(3)(i) of this section, B and L must apply the rules in paragraphs
(h)(3)(iii)(A), (B) and (C) of this section to determine whether the
fallback waterfall is a qualified rate. Under paragraph (h)(3)(iii)(A)
of this section, because the rate being tested as a qualified rate
(i.e., the fallback waterfall) is comprised of more than one fallback
rate, the fallback waterfall is a qualified rate only if each
individual fallback rate (i.e., the fallback rates in the first and
second tiers of the fallback waterfall) separately satisfies the
requirements to be a qualified rate. As concluded in paragraph
(h)(3)(iv)(D)(3) of this section, the fallback rate in the second tier
of the fallback waterfall is treated as not satisfying the requirements
to be a qualified rate. Therefore, the fallback waterfall is not a
qualified rate.
(3) Analysis of the second tier of the fallback waterfall. As
provided in paragraphs (h)(3)(i) and (h)(3)(iii)(A) of this section, B
and L must apply the rules in paragraphs (h)(3)(iii)(B) and (C) of this
section to determine whether the fallback rate in the second tier of
the fallback waterfall is a qualified rate. Because the likelihood that
Benchmark X will be discontinued is not remote, paragraph
(h)(3)(iii)(C) of this section has no effect on the analysis of the
fallback rate in the second tier of the fallback waterfall. Under
paragraph (h)(3)(iii)(B) of this section, because it is not possible to
determine at the time of the fallback waterfall's addition in 2022
whether the fallback rate in the second tier of the fallback waterfall
(i.e., the replacement rate that B will select in 2023) satisfies the
requirements set forth in the first sentence of paragraph (h)(3)(i) of
this section, the fallback rate in the second tier of the fallback
waterfall is treated as not satisfying the requirements to be a
qualified rate.
(4) Discontinued IBOR. A discontinued IBOR is any interbank offered
rate described in paragraph (h)(4)(i) or (ii) of this section but only
during the period beginning on the date of the announcement described
in paragraph (h)(4)(i) or (ii) of this section and ending on the date
that is one year after the date on which the administrator of the
interbank offered rate ceases to provide the interbank offered rate.
(i) The administrator of the interbank offered rate announces that
the administrator has ceased or will cease to provide the interbank
offered rate permanently or indefinitely, and no successor
administrator is expected as of the time of the announcement to
continue to provide the interbank offered rate; or
(ii) The regulatory supervisor for the administrator of the
interbank offered rate, the central bank for the currency of the
interbank offered rate, an insolvency official with jurisdiction over
the administrator for the interbank offered rate, a resolution
authority with jurisdiction over the administrator for the interbank
offered rate, a court, or an entity with similar insolvency or
resolution authority over the administrator for the interbank offered
rate announces that the administrator of the interbank offered rate has
ceased or will cease to provide the interbank offered rate permanently
or indefinitely, and no successor administrator is expected as of the
time of the announcement to continue to provide the interbank offered
rate.
(5) Associated modification. An associated modification is a
modification of the technical, administrative, or operational terms of
a contract that is reasonably necessary to adopt or to implement the
modifications described in paragraph (h)(1)(i), (ii), or (iii) of this
section other than associated modifications. An associated modification
also includes an incidental cash payment intended to compensate a
counterparty for small valuation differences resulting from a
modification of the administrative terms of a contract, such as the
valuation differences resulting from a change in observation period.
Examples of associated modifications include a change to the definition
of interest period or a change to the timing and frequency of
determining rates and making payments of interest (for example,
delaying payment dates on a debt instrument by two days to allow
sufficient time to compute and pay interest at a qualified rate
computed in arrears).
(6) Qualified one-time payment. A qualified one-time payment is a
single cash payment that is intended to compensate the other party or
parties for all or part of the basis difference between the
discontinued IBOR identified in paragraph (h)(1)(i), (ii), or (iii) of
this section and the interest rate benchmark to which the qualified
rate refers.
(i) [Reserved]
(j) Modifications excluded from the definition of covered
modification. A modification or portion of a modification described in
any of paragraphs (j)(1) through (5) of this section is excluded from
the definition of covered modification in paragraph (h)(1) of this
section and therefore is a noncovered modification.
[[Page 180]]
(1) The terms of the contract are modified to change the amount or
timing of contractual cash flows and that change is intended to induce
one or more parties to perform any act necessary to consent to a
modification to the contract described in paragraph (h)(1)(i), (ii), or
(iii) of this section. See paragraph (j)(6)(iii) of this section
(Example 3).
(2) The terms of the contract are modified to change the amount or
timing of contractual cash flows and that change is intended to
compensate one or more parties for a modification to the contract not
described in paragraph (h)(1)(i), (ii), or (iii) of this section. See
paragraph (j)(6)(v) of this section (Example 5).
(3) The terms of the contract are modified to change the amount or
timing of contractual cash flows and that change is either a concession
granted to a party to the contract because that party is experiencing
financial difficulty or a concession secured by a party to the contract
to account for the credit deterioration of another party to the
contract. See paragraph (j)(6)(vi) of this section (Example 6).
(4) The terms of the contract are modified to change the amount or
timing of contractual cash flows and that change is intended to
compensate one or more parties for a change in rights or obligations
that are not derived from the contract being modified. See paragraph
(j)(6)(vii) of this section (Example 7). If each contract in a given
portfolio of contracts has the same parties, those parties modify more
than one contract in the portfolio (each such contract is a modified
portfolio contract), and those modifications provide for a single,
aggregate qualified one-time payment with respect to all modified
portfolio contracts, then the portion of the qualified one-time payment
allocable to any one modified portfolio contract is treated for
purposes of this paragraph (j)(4) as not intended to compensate for a
change in rights or obligations derived from any other modified
portfolio contract.
(5) The terms of the contract are modified to change the amount or
timing of contractual cash flows and the modification is identified for
purposes of this paragraph (j)(5) in guidance published in the Internal
Revenue Bulletin (see Sec. 601.601(d)(2)(ii)(a) of this chapter) as
having a principal purpose of achieving a result that is unreasonable
in light of the purpose of this section.
(6) Examples. The following examples illustrate the operation of
the rules in paragraphs (j)(1) through (4) of this section.
(i) Example 1: Covered modification--(A) Facts. B is the issuer and
L is the holder of a debt instrument that pays interest semiannually at
a rate of six-month USD LIBOR plus 100 basis points. On July 1, 2022, B
and L modify the debt instrument to replace that original rate with CME
Group's forward-looking SOFR term rate of a six-month tenor (six-month
CME Term SOFR) plus an adjustment spread of 42.826 basis points plus
100 basis points (the whole modification is the LIBOR replacement
modification with basis adjustment spread). B and L chose the
adjustment spread of 42.826 basis points because that is the adjustment
spread used or recommended by the International Swaps and Derivatives
Association and the Alternative Reference Rates Committee for similar
substitutions or replacements of six-month USD LIBOR with a tenor-
adjusted variant of SOFR.
(B) Analysis. The parties have modified the terms of the debt
instrument to replace a rate referencing a discontinued IBOR (i.e.,
six-month USD LIBOR plus 100 basis points) with a qualified rate (i.e.,
six-month CME Term SOFR plus 142.826 basis points). The LIBOR
replacement modification with basis adjustment spread is described in
paragraph (h)(1)(i) of this section and not described in any of
paragraphs (j)(1) through (5) of this section. Therefore, the LIBOR
replacement modification with basis adjustment spread is a covered
modification of the debt instrument.
(ii) Example 2: Covered modification with qualified one-time
payment--(A) Facts. The facts are the same as in paragraph (j)(6)(i)(A)
of this section (Example 1), except that, instead of the LIBOR
replacement modification with basis adjustment spread, B and L modify
the debt instrument by replacing the original rate of six-month USD
LIBOR plus 100 basis points with six-month CME Term SOFR plus 100 basis
points and by obligating B to make a cash payment to L equal to the
present value of the adjustment spread of 42.826 basis points with
respect to the debt instrument (this payment is the basis adjustment
payment, and the whole modification is the LIBOR replacement
modification with basis adjustment payment).
(B) Analysis. The parties have modified the terms of the debt
instrument to replace a rate referencing a discontinued IBOR (i.e.,
six-month USD LIBOR plus 100 basis points) with a qualified rate (i.e.,
six-month CME Term SOFR plus 100 basis points) and have added an
obligation for B to make the basis adjustment payment, which is a
single cash payment that is intended to compensate L for the basis
difference between the discontinued IBOR identified in paragraph
(h)(1)(i) of this section (i.e., six-month USD LIBOR) and the interest
rate benchmark to which the qualified rate refers (i.e., six-month CME
Term SOFR). Accordingly, the basis adjustment payment is a qualified
one-time payment as defined in paragraph (h)(6) of this section, and
the LIBOR replacement modification with basis adjustment payment is
described in paragraph (h)(1)(i) of this section. Because it is
described in paragraph (h)(1)(i) of this section and not described in
any of paragraphs (j)(1) through (5) of this section, the LIBOR
replacement modification with basis adjustment payment is a covered
modification of the debt instrument.
(iii) Example 3: Inducement spread--(A) Facts. The facts are the
same as in paragraph (j)(6)(i)(A) of this section (Example 1), except
that the debt instrument is part of a widely held issue of debt with
identical terms. Under the trust indenture applicable to the debt
instrument, if B proposes a modification of the terms of the debt and
all holders of the debt consent to that modification, the terms of the
debt are modified as B proposed. In accordance with the trust
indenture, B proposes the LIBOR replacement modification with basis
adjustment spread on January 1, 2022. To induce holders such as L to
perform the acts necessary to consent to the LIBOR replacement
modification with basis adjustment spread, B also proposes to increase
the interest rate paid to each consenting holder by an additional
spread of 10 basis points (the inducement spread). All holders,
including L, consent to B's proposed modifications by June 1, 2022. On
July 1, 2022, the debt instrument is modified to implement the LIBOR
replacement modification with basis adjustment spread and to increase
the interest rate by the inducement spread. Once all modifications are
effective, the debt instrument pays interest at a rate of six-month CME
Term SOFR plus 152.826 basis points.
(B) Analysis. As concluded in paragraph (j)(6)(i)(B) of this
section (Example 1), the portion of these modifications that implements
the LIBOR replacement modification with basis adjustment spread is a
covered modification of L's debt instrument. However, the portion of
these modifications that increases the interest rate by the inducement
spread changes the amount of cash flows on L's debt instrument, and
that change is intended to induce L to perform the acts
[[Page 181]]
necessary to consent to a modification to the debt instrument described
in paragraph (h)(1)(i) of this section (i.e., the LIBOR replacement
modification with basis adjustment spread). Therefore, the portion of
the modification that increases the interest rate by the inducement
spread is described in paragraph (j)(1) of this section and,
consequently, is a noncovered modification of L's debt instrument. See
paragraph (b)(2) of this section for the treatment of a contemporaneous
noncovered modification.
(iv) Example 4: Consent fee--(A) Facts. The facts are the same as
in paragraph (j)(6)(iii)(A) of this section (Example 3), except that,
instead of proposing to increase the interest rate paid to each
consenting holder by the inducement spread, B proposes to make a cash
payment to each consenting holder (the consent fee) at the time of the
modification. Thus, when the proposed modification occurs on July 1,
2022, B pays all holders, including L, the consent fee. Once all
modifications are effective, the debt instrument pays interest at a
rate of six-month CME Term SOFR plus 142.826 basis points.
(B) Analysis. As concluded in paragraph (j)(6)(i)(B) of this
section (Example 1), the LIBOR replacement modification with basis
adjustment spread is a covered modification of L's debt instrument.
However, B's obligation to pay the consent fee is also a modification
of L's debt instrument but is not a covered modification because it is
not described in paragraph (h)(1)(i) of this section. In particular,
B's obligation to pay the consent fee is not an associated modification
because it is not a modification of the technical, administrative, or
operational terms of L's debt instrument and is not intended to
compensate for valuation differences resulting from a modification of
the administrative terms of L's contract. Nor is the consent fee a
qualified one-time payment because it is not intended to compensate L
for any part of the basis difference between the discontinued IBOR
identified in paragraph (h)(1)(i) of this section (i.e., six-month USD
LIBOR) and the interest rate benchmark to which the qualified rate
refers (i.e., six-month CME Term SOFR). See paragraph (b)(2) of this
section for the treatment of a contemporaneous noncovered modification.
(v) Example 5: Compensation for a modification to a customary
financial covenant--(A) Facts. The facts are the same as in paragraph
(j)(6)(i)(A) of this section (Example 1), except that, at the same time
as and for reasons unrelated to the LIBOR replacement modification with
basis adjustment spread, B and L also modify customary financial
covenants in the debt instrument in a manner that benefits B. In
exchange for the modification of customary financial covenants, B
agrees to add another 30 basis points to the rate such that, once all
modifications are effective, the debt instrument pays interest at a
rate of six-month CME Term SOFR plus 172.826 basis points.
(B) Analysis. As concluded in paragraph (j)(6)(i)(B) of this
section (Example 1), the portion of these modifications that implements
the LIBOR replacement modification with basis adjustment spread is a
covered modification of the debt instrument. However, the portion of
these modifications that modifies customary financial covenants is not
related to the replacement of LIBOR and, therefore, is not described in
any of paragraphs (h)(1)(i), (ii), or (iii) of this section and,
therefore, is a noncovered modification of the debt instrument.
Moreover, the portion of these modifications that adds 30 basis points
to the rate changes the amount of cash flows on the debt instrument,
and the parties intend that change to compensate L for a modification
to the debt instrument not described in paragraph (h)(1)(i), (ii), or
(iii) of this section (i.e., the modification of customary financial
covenants). Therefore, the portion of these modifications that adds
those 30 basis points to the rate is described in paragraph (j)(2) of
this section and, consequently, is a noncovered modification of the
debt instrument. See paragraph (b)(2) of this section for the treatment
of a contemporaneous noncovered modification.
(vi) Example 6: Workout of distressed debt--(A) Facts. The facts
are the same as in paragraph (j)(6)(i)(A) of this section (Example 1),
except that B's financial condition has deteriorated since the issue
date of the debt instrument and, to decrease the risk of B's default or
bankruptcy, L agrees to subtract 50 basis points from the rate such
that, once all modifications are effective, the debt instrument pays
interest at a rate of six-month CME Term SOFR plus 92.826 basis points.
(B) Analysis. As concluded in paragraph (j)(6)(i)(B) of this
section (Example 1), the portion of these modifications that implements
the LIBOR replacement modification with basis adjustment spread is a
covered modification of the debt instrument. However, the portion of
these modifications that subtracts 50 basis points from the rate
changes the amount of cash flows on the debt instrument, and that
change is a concession granted to B because B is experiencing financial
difficulty. Therefore, the portion of these modifications that
subtracts those 50 basis points from the rate is described in paragraph
(j)(3) of this section and, consequently, is a noncovered modification
of the debt instrument. See paragraph (b)(2) of this section for the
treatment of a contemporaneous noncovered modification.
(vii) Example 7: Change in rights or obligations not derived from
the modified contract--(A) Facts. B is the issuer and L is the holder
of a debt instrument (Debt X) with respect to which the facts are the
same as in paragraph (j)(6)(i)(A) of this section (Example 1). In
addition, B and L are the issuer and holder, respectively, of a second
debt instrument (Debt Y). At the same time that the LIBOR replacement
modification with basis adjustment spread occurs with respect to Debt
X, B and L also modify customary financial covenants in Debt Y in a
manner that benefits B. In exchange for the modification of customary
financial covenants in Debt Y, B agrees to add another 30 basis points
to the rate on Debt X such that, once all modifications are effective,
Debt X pays interest at a rate of six-month CME Term SOFR plus 172.826
basis points.
(B) Analysis. As concluded in paragraph (j)(6)(i)(B) of this
section (Example 1), the portion of these modifications that implements
the LIBOR replacement modification with basis adjustment spread is a
covered modification of Debt X. However, the portion of these
modifications that adds 30 basis points to the rate on Debt X changes
the amount of cash flows on Debt X, and the parties intend that change
to compensate L for a change in rights or obligations that are not
derived from Debt X (i.e., the modification of customary financial
covenants in Debt Y). Therefore, the portion of these modifications
that adds those 30 basis points to the rate on Debt X is described in
paragraph (j)(4) of this section and, consequently, is a noncovered
modification of Debt X. See paragraph (b)(2) of this section for the
treatment of a contemporaneous noncovered modification.
(k) Applicability date. This section applies to a modification of
the terms of a contract that occurs on or after March 7, 2022. A
taxpayer may choose to apply this section to modifications of the terms
of contracts that occur before March 7, 2022, provided that the
taxpayer and all related parties (within the meaning of section 267(b)
or section 707(b)(1) or within the meaning of Sec. 1.150-1(b) for a
taxpayer that is a State
[[Page 182]]
or local governmental unit (as defined in Sec. 1.103-1(a)) or a
501(c)(3) organization (as defined in section 150(a)(4))) apply this
section to all modifications of the terms of contracts that occur
before that date. See section 7805(b)(7).
0
Par. 6. Section 1.1271-0 is amended by adding entries for Sec. 1.1275-
2(m) to read as follows:
Sec. 1.12711-0 Original issue discount; effective date; table of
contents.
* * * * *
Sec. 1.12751-2 Special rules relating to debt instruments.
* * * * *
(m) Transition from certain interbank offered rates.
(1) In general.
(2) Single qualified floating rate.
(3) Remote contingency.
(4) Change in circumstances.
(5) Applicability date.
* * * * *
0
Par. 7. Section 1.1275-2 is amended by adding paragraph (m) to read as
follows:
Sec. 1.12751 -2 Special rules relating to debt instruments.
* * * * *
(m) Transition from certain interbank offered rates--(1) In
general. This paragraph (m) applies to a variable rate debt instrument
(as defined in Sec. 1.1275-5(a)) that provides both for a qualified
floating rate that references a discontinued IBOR and for a methodology
to change that rate referencing a discontinued IBOR to a different rate
in anticipation of the discontinued IBOR becoming unavailable or
unreliable. For purposes of this paragraph (m), discontinued IBOR has
the meaning provided in Sec. 1.1001-6(h)(4). See Sec. 1.1001-6 for
additional rules that may apply to a debt instrument that provides for
a rate referencing a discontinued IBOR.
(2) Single qualified floating rate. If a debt instrument is
described in paragraph (m)(1) of this section, the rate referencing a
discontinued IBOR and the different rate are treated as a single
qualified floating rate for purposes of Sec. 1.1275-5.
(3) Remote contingency. If a debt instrument is described in
paragraph (m)(1) of this section, the possibility that the discontinued
IBOR will become unavailable or unreliable is treated as a remote
contingency for purposes of paragraph (h) of this section.
(4) Change in circumstances. If a debt instrument is described in
paragraph (m)(1) of this section, the fact that the discontinued IBOR
has become unavailable or unreliable is not treated as a change in
circumstances for purposes of paragraph (h)(6) of this section.
(5) Applicability date. Paragraph (m) of this section applies to
debt instruments issued on or after March 7, 2022. A taxpayer may
choose to apply paragraph (m) of this section to debt instruments
issued before March 7, 2022, provided that the taxpayer and all related
parties (within the meaning of section 267(b) or section 707(b)(1) or
within the meaning of Sec. 1.150-1(b) for a taxpayer that is a State
or local governmental unit (as defined in Sec. 1.103-1(a)) or a
501(c)(3) organization (as defined in section 150(a)(4))) apply
paragraph (m) of this section to all debt instruments issued before
that date. See section 7805(b)(7).
0
Par. 8. Section 1.7701(l)-3 is amended by adding a sentence at the end
of paragraph (b)(2)(ii) to read as follows:
Sec. 1.77011 (l)-3 Recharacterizing financing arrangements involving
fast-pay stock.
* * * * *
(b) * * *
(2) * * *
(ii) * * * See Sec. 1.1001-6(e) for additional rules that may
apply to stock that provides for a rate referencing a discontinued
IBOR, as defined in Sec. 1.1001-6(h)(4).
* * * * *
PART 301--PROCEDURE AND ADMINISTRATION
0
Par. 9. The authority citation for part 301 continues to read in part
as follows:
Authority: 26 U.S.C. 7805 * * *
0
Par. 10. Section 301.7701-4 is amended by adding a sentence at the end
of paragraph (c)(1) to read as follows:
Sec. 301.7701301-4 Trusts.
* * * * *
(c) * * *
(1) * * * See Sec. 1.1001-6(f) of this chapter for additional
rules that may apply to an investment trust that holds one or more
contracts that provide for a rate referencing a discontinued IBOR, as
defined in Sec. 1.1001-6(h)(4) of this chapter, and for additional
rules that may apply to an investment trust with one or more ownership
interests that reference a discontinued IBOR.
* * * * *
Douglas W. O'Donnell,
Deputy Commissioner for Services and Enforcement.
Approved: December 19, 2021.
Lily Batchelder,
Assistant Secretary of the Treasury (Tax Policy).
[FR Doc. 2021-28452 Filed 12-30-21; 4:15 pm]
BILLING CODE 4830-01-P
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</html>Indexed from Federal Register on January 4, 2022.
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