Common tax implications of changes made to financial arrangements due to Inter-bank offered rate (IBOR) reform.
What is IBOR reform?
IBORs, including the London Inter-Bank Offered Rate (LIBOR), Euro Inter-bank Offered Rate (EURIBOR), and the US Effective Federal Funds Rate are interest rate benchmarks. They are commonly used to determine interest rates and payment obligations for a wide range of financial arrangements such as loans, bonds and derivatives.
IBORs are at various stages of reform to transition to alternative near Risk Free Rates (RFRs), such as the Secured Overnight Financing Rate (SOFR) for USD, Euro Short-Term Rate (€STR) for EUR and Sterling Overnight Inter-bank Average Rate (SONIA) for GBP. In particular, LIBOR, one of the most widely used IBORs in financial markets, ceased to be published in a number of currencies at the end of 2021.
Transitioning to RFRs is a complex process as RFRs are structurally different from IBORs. It is expected most financial arrangements that provide for IBOR-based payments will need to be modified to accommodate this transition.
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.
Who should use this guide
This guide applies to you if you make changes to the contractual terms of your financial arrangements due to IBOR reform. That is, you make changes to your contracts for the sole purpose of responding to a transition from a particular IBOR to an alternative RFR or other replacement benchmark rate.
This guide does not cover tax consequences associated with amendments made to financial arrangements which do not relate to IBOR reform.
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. In making changes to legacy contracts as a result of IBOR 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.
If you are a party to a financial arrangement impacted by IBOR reform, you need to be aware of the tax consequences. These will vary depending on the nature of your circumstances. You may want to seek professional tax advice to help you to make an informed decision as to the tax effect of any amendment you make to your contracts due to IBOR reform.
This guide is of a general nature and is based on the law and the ATO’s understanding of the state of play in relation to IBOR reform as at the date of publication.
Find out about the background to IBOR reform and who should use this guide.