Banking and Business Monthly – January 2022

On December 30, 2021, the Treasury Department and IRS issued final regulations to address the taxability of modifications that replace LIBOR or another interbank offered rate (“IBOR”) with a qualified rate such as the Secured Overnight Financing Rate (“SOFR”). See https://www.govinfo.gov/content/pkg/FR-2022-01-04/pdf/2021-28452.pdf. These final regulations apply to all modifications, whether effected through an amendment, an exchange, a retirement and reissuance, or otherwise, and to all “contracts,” which are defined broadly to include all debt, equity, and derivative instruments. These modifications will take effect 60 days following the publication of the regulations in the federal register on January 4, 2022.

Under the final regulations, a covered modification is not treated as the “exchange for other property differing materially in kind,” and therefore is not taxable. A covered modification includes any modification where:

1. The terms of the contract are modified to replace an operative rate that uses a discontinued IBOR with a qualified rate and any related modifications;
2. The terms of the contract are modified to add a qualified rate as a fallback to an operative rate that references a discontinued IBOR and any related modifications; or
3. The terms of the contract are modified to replace a fallback rate that references a discontinued IBOR with a qualified rate and any related modifications.

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

A qualified rate is a SOFR-based or other qualified replacement rate, selected or endorsed by the central bank, reserve bank, or similar institution as a replacement for a discontinued IBOR or its currency equivalent in a specific jurisdiction. Qualified rates include these recommended by the Alternative Reference Rates Committee (“ARRC”).

Modifications can have covered and non-covered components. Covered modifications can also include a one-time payment, which is a single payment that compensates a party for the difference between the discontinued and the replacement rate. These covered modifications may include technical, administrative, operational, or other associated modifications. Noncovered modifications are any modifications that are not covered modifications. These noncovered modifications must be tested on a standalone basis under the general modification rules to determine whether they cause a taxable event. When a noncovered modification is effected contemporaneously with a covered modification, taxpayers must test the noncovered modification as if the contract already included the covered modification.

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