The Australian Taxation Office (ATO) has published a discussion paper on the tax implications of Inter-bank Offered Rate reform. The deadline for comments is 17 December 2021.
Common tax consequences of changes made to financial arrangements driven by Inter-bank Offered Rate reform
What this discussion paper is about
1. Interest rate benchmarks, including the London Inter-bank Offered Rate (LIBOR), the Euro Inter-bank Offered Rate (EURIBOR), the United States of America's Effective Federal Funds Rate and other Inter-bank Offered Rate (IBOR) benchmarks are at various stages of reform and transitioning to alternative risk-free rates (RFRs). These RFRs are typically administered and published by major central banks worldwide and include:
- the Secured Overnight Financing Rate (SOFR), in respect of US Dollar (USD) borrowings
- the Euro short-term rate (€STR), in respect of Euro (EUR) borrowings, and
- the Sterling Overnight Interbank Average Rate (SONIA), in respect of British pound sterling (GBP) borrowings.
2. Transitioning to RFRs will be a complex process for the industry as RFRs are structurally different from IBORs and it is expected most financial arrangements such as loans, bonds and derivatives that provide for IBOR-based payments will need to be modified to accommodate this transition.
3. On 5 March 2021, the United Kingdom's (UK's) Financial Conduct Authority (FCA) announced that the majority of LIBOR settings will cease to be quoted from 31 December 2021. Accordingly, businesses may be looking to modify the contracts of impacted IBOR-based financial arrangements by:
- replacing the existing benchmark rate in the relevant agreement with an alternative RFR
- amending existing fallback clauses, or introducing fallback clauses where they do not currently exist
- making other incidental variations to contracts as a direct consequence of IBOR reform, such as additional payments or credit spread adjustments to be made for the purposes of preserving the parties' economic positions.
4. In making changes to legacy contracts as a result of LIBOR reform, parties may choose to adopt market consensus in terms of standard language and IBOR fallback rate adjustments consistent with published international guidance by relevant industry and regulatory bodies including:
- the Alternative Reference Rates Committee, including its Guiding Principles
- the Working Group on Sterling Risk-Free Reference Rates
- the Working Group on Euro Risk-Free Reference Rates
- the National Working Group on Swiss Franc (CHY) Reference Rates
- the Cross-Industry Committee on Japanese Yen (JPY) Interest Rate Benchmarks
- the International Swaps and Derivatives Association (ISDA), including the ISDA 2020 IBOR Fallbacks Protocol; and the Fallback Supplement to the 2006 ISDA Definitions
- Bloomberg, including its IBOR Fallback Rate Adjustment Rule Book
- the Loan Market Association (LMA), including its template terms.
Purpose of this discussion paper
5. The ATO is seeking your input through this discussion paper on the tax considerations arising from IBOR reform (including the cessation of LIBOR) so that we can provide you with relevant advice and guidance to assist you in complying with your tax obligations. It is currently proposed that the final guidance on the tax considerations arising from IBOR reform will be published as higher-level web-based content on the ATO website.
6. The ATO invites interested parties to provide written submissions on any relevant issues or specific concerns about the matters raised in this discussion paper, including any areas of tax law arising from IBOR reform which you think are unclear or cause difficulties. We also encourage feedback on the proposed form and structure of the final guidance.
7. This discussion paper sets out common tax considerations that you should consider with respect to changes made to certain financial arrangements that are driven by IBOR reform; that is, changes to contractual terms made for the sole purpose of responding to a transition from a particular IBOR to an alternative RFR or other replacement benchmark rate. Although this discussion paper refers to LIBOR, it applies equally to other IBORs which are subject to reform. The focus of this discussion paper is on financial arrangements that are capable of being subject to the taxation of financial arrangements (TOFA) regime.]
8. Examples of changes which are likely to be driven by IBOR reform include:
- the implementation of market conventions applicable to the RFR or replacement rate into the contract, such as amending or incorporating fallback clauses (or market disruption provisions) for a temporary or permanent RFR or other IBOR replacement rate unavailability scenario, and
- making other incidental variations to contracts as a direct consequence of IBOR reform, such as additional payments (or credit spread adjustments) to be made for the purpose of preserving the parties' economic positions and reducing or eliminating (to the extent possible) any potential transfer of economic value from one party to another as a result of the transition from IBOR to replacement rates.
9. The content of this discussion paper reflects the ATO's current understanding of the expected changes as at 30 October 2021.