Amending or creating contracts
Depending on the terms and conditions of the legal contracts involved, as a matter of contract law, the amendment of a legal contract will result in either the:
- continuation of the legal contract (that is, a variation of the existing contract), or
- creation of a new legal contract (that is, a rescission of the existing contract).
The intention of the parties as reflected in the amendments to the legal contractFootnote1, and the significance of the amendments in altering the substance of the original contractFootnote2, will be significant factors in determining whether the changes constitute a variation of an existing legal contract or the redemption and replacement of an existing legal contract. This is a question of fact to be determined by reference to all the facts and circumstances of each case.
Where the parties agree to change the terms of the contract for the sole purpose of responding to IBOR changes such as the withdrawal of LIBOR, the ATO expects that in most cases this is likely to be characterised as a variation of the existing contract rather than the creation of a new legal contract. This would apply, for example, where the parties intend to maintain the existing contract and agree to replace LIBOR with one of the new RFRs. In that case, we would generally expect to also see adjustmentsFootnote3 to be made to the contract to broadly maintain the substance of the arrangement (and take into account material differences between LIBOR and the relevant RFR).
An amendment to a legal contract should be analysed by both parties by determining the position agreed between the parties to the contract and whether this represents a variation to an existing contract or a rescission of an existing contract and the creation of a new contract.Footnote4 Each party should form a view on the legal effect of the amendments made and have suitable processes in place to evidence the legal view that has been reached for a given contract or a portfolio of contracts with near-identical terms and conditions.
The way the amendment is recorded in an internal system (for example, by cancelling an existing entry and booking a new entry in the system) will not determine the legal effect of the amendment.
Where fallback provisions come into operation according to the existing terms of the original agreement (that is, there is no amendment to an existing legal contract), this should not be regarded as a variation to the contract and therefore in the absence of any other changes it will not be necessary to consider whether a new contract has been created.
You may want to seek professional advice to help you to make an informed decision regarding the legal effect of any amendment you make to your contracts as a result of IBOR reform.
Tax implications where changes only vary the original contract
Where an IBOR amendment results in the variation of the contract, and the contract represents a financial arrangement that is subject to the TOFA regime, there may be an assessable gain or deductible loss for tax purposes depending on the particular TOFA tax-timing methods which apply.
If you have made a TOFA tax-timing method election which relies on the way that a financial arrangement is treated under the accounting standards, such as the reliance on financial reports (ROFR) method or some other relevant elective method, the income tax consequences should largely follow the accounting outcomes.
For example, a spread adjustment or different term structure of the financial arrangement to reflect the new RFR may result in a credit or debit adjustment to the profit and loss of the parties and this may trigger an assessable gain or deductible loss for tax under the TOFA regime.
If you have not elected the ROFR method or any other elective method, you may need to re-assess or re-estimate your loans under the TOFA accruals/realisation method in Subdivision 230-B of the ITAA 1997.
If the relevant financial arrangement is not subject to the TOFA regime, the income tax consequences of a variation to the contract will depend on provisions outside the TOFA regime, such as the ordinary income and deduction provisions (Divisions 6 and 8 of the ITAA 1997) and Division 16E of the Income Tax Assessment Act 1936 (ITAA 1936).
Tax implications where changes rescind the original contract and create a new one
Where an IBOR amendment to the contract results in all the taxpayer’s rights and/or obligations under the relevant financial arrangement ceasing, this will give rise to a balancing adjustment under Subdivision 230-G of the TOFA regime.
If the financial arrangement is not subject to the TOFA rules, you may need to consider the tax implications in sections 26BB and 70B, or Division 16E, of the ITAA 1936, where the financial instrument is a traditional security or qualifying security (which requires consideration of whether there has been a redemption of the security).
Where the impacted financial arrangement is held on capital account, the termination of the original contract may also result in consequences under the capital gains tax rules; for example, CGT event C2.
Businesses should consider the income tax effect of changes made to existing financial arrangements due to IBOR reform.- Footnote 1
- Tallerman & Co Pty Ltd v Nathan's Merchandise (Vic) Pty Ltd [1957] HCA 10.
- Footnote 2
- Morris v Baron & Co [1918] AC 1.
- Footnote 3
- For example, amendment to the spread or margin or the requirement of additional payments to be made between the parties.
- Footnote 4
- We accept that the legal analysis may include consideration of the accounting treatment or analysis of amendments to a contract or contract in a portfolio of contracts with near-identical terms and conditions. However, it will generally not be appropriate to rely solely on the accounting treatment and you should maintain contemporaneous documentation which explains the legal analysis undertaken and the way the accounting treatment was used in the analysis.