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Responding to IBOR reform – examples

See how the tax implications of IBOR reform will play out in various scenarios.

Last updated 2 February 2023

Common tax issue examples that may arise as a result of changes made to financial arrangements driven by IBOR.

To illustrate some of the more common tax issues that may arise as a result of changes made to financial arrangements driven by IBOR, the principles discussed in this guide are provided in the examples below, which build upon the following high-level scenario.

Responding to IBOR reform – scenario

In response to IBOR reform, ABC Ltd, an Australian entity subject to the TOFA regime, has made changes to contracts underpinning its financial arrangements which contain references to any IBOR-related benchmark rates (IBOR-impacted arrangements), such as:

  • 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.

ABC Ltd has undertaken (and is able to demonstrate that it has undertaken) a legal assessment of all changes made to its financial contracts in response to IBOR reform (either on an individual contract basis or a portfolio basis for contracts with near-identical terms and conditions). As a result of this assessment, it has determined that:

  • in most circumstances, the changes made to each contract/relevant portfolio for IBOR reform are minor and would be considered a variation to the original contract
  • the amendments are intended to ensure that the fair value of the original transaction is substantially equivalent and the economic position of each party is broadly maintained
  • in certain circumstances, the changes made to a contract are significant, inconsistent with the original contract and reflect the intention of both parties to rescind the original transaction and create a new contract.
Start of example

Example 1; contract variations consistent with market standard terms

One of the various IBOR-impacted arrangements identified by ABC Ltd is a four-year GBP floating rate facility provided to XYZ PLC (its UK subsidiary) in 2020. The interest rate for this debt facility is 3M GBP LIBOR + 1%. The existing fallback language in the facility agreement contains a historic standard LMA rate calculation clause which defaults to the last LIBOR screen rate in the event that LIBOR is no longer available. That is, in the absence of any legislative or prudential remedies dealing with legacy contracts, the existing fallback language will change the facility into a fixed-rate facility based on the last published LIBOR rate on 31 December 2021.

In response to IBOR reform, ABC Ltd and XYZ PLC agree to amend the relevant contract by inserting standard LMA provisions relating to the transition from LIBOR to SONIA. The amendments include replacement of the existing LIBOR reference rate with SONIA, as well as the inclusion of industry-accepted fixed credit spread adjustments and a methodology to calculate the compounded SONIA rate. The fair value of the amended facility (at the time of amendment) is substantially equivalent to the original facility (just before the amendment). The changes are consistent with the transitioning of ABC Ltd's similar arrangements with third-party customers.

TOFA consequences

Based on the fact pattern in this example, the ATO considers that the amendment is a variation and does not rescind the original contract. As ABC Ltd is subject to the TOFA regime, there is no balancing adjustment gain or loss for ABC Ltd under Subdivision 230-G of the ITAA 1997. However, there may be an assessable gain or deductible loss for tax depending on the specific rules applicable to ABC Ltd under the TOFA regime.

If the TOFA regime does not apply, the income tax consequences of a contract variation 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 ITAA 1936.

Transfer pricing

The changes were considered to be in line with market practice, consistent with the transitioning of ABC Ltd's third-party arrangements and limited to variation of contractual terms necessary to implement the transition. The ATO will generally view the changes as having a low likelihood of resulting in a transfer pricing benefit. ABC Ltd should maintain contemporaneous documentation which records and explains the changes made and compliance with the arm’s length principle.

End of example

 

Start of example

Example 2: third-party contract amendments consistent with market standard terms

One of the various IBOR-impacted arrangements identified by ABC Ltd is a nine-year cross-currency interest rate swap entered into with its Australian third-party customer DCE Pty Ltd. The cross-currency interest rate swap is used by DCE Pty Ltd to hedge a EUR exposure arising from a EUR-denominated term funding raised offshore.

ABC Ltd and DCE Pty Ltd pay interest rates inclusive of margins based on 3M BBSW and 3M EURIBOR respectively.

In response to IBOR reform, ABC Ltd and DCE Pty Ltd agree to amend the terms of the relevant contract in accordance with the terms of the ISDA 2020 IBOR Fallbacks Protocol relating to the transition from EURIBOR to €STR. The fair value of the amended facility (at the time of amendment) is substantially equivalent to the original facility (just before the amendment).

TOFA consequences

Based on the fact pattern in this example, the ATO considers that the amendment is a variation and does not rescind the original contract. As ABC Ltd is subject to the TOFA regime, there is no balancing adjustment gain or loss for ABC Ltd under Subdivision 230-G of the ITAA 1997. However, there may be an assessable gain or deductible loss for tax depending on the specific rules applicable to ABC Ltd under the TOFA regime.

If the TOFA regime does not apply, the income tax consequences of a contract variation 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 ITAA 1936.

End of example

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