The Internal Revenue Service (IRS) released Revenue Procedure 2020-44 to assist the market's transition from the London Interbank Offered Rate (Libor) and other interbank offered rates (IBORs) to alternative reference rates by promoting the adoption of fallback language recommended by the Alternative Reference Rates Committee (ARRC) and the International Swaps and Derivatives Association (ISDA). (See previous Holland & Knight alert, "Treasury Department, IRS Issue Proposed Rules on Tax Impact of Transition from Libor," Oct. 28, 2019.)
The Financial Conduct Authority has stated that all currency and term variants of Libor, including U.S.-dollar (USD) Libor, will be phased out by June 30, 2023, or earlier. To support the transition from USD Libor, ARRC and ISDA have published fallback language for inclusion in the terms of certain new financial products, including floating rate notes, bilateral business loans, floating-rate debt instruments, syndicated loans, securitizations, derivatives and adjustable rate mortgages. The ARRC and ISDA fallback language describes the circumstances under which references to the current benchmark rate are replaced. When such a circumstance arises, the fallback language provides a mechanism for determining the replacement benchmark rate that replaces the IBOR. The ARRC and ISDA fallbacks also include a spread adjustment that is based upon an analysis of the IBOR and the replacement reference rate.
Revenue Procedure 2020-44 provides that modifications to an IBOR-based contract, including a tax-exempt loan, will not be treated as a taxable event. It also provides that such modifications will not be treated as the closing of a position to an integrated transaction, a termination of a qualified hedge, or as a disposition or termination of either leg of a hedging transaction. The revenue procedure is effective for modifications to contracts occurring on or after Oct. 9, 2020, and before Jan. 1, 2023, and taxpayers may rely on it for modifications to contracts occurring before Oct. 9, 2020. It is important to note that the procedure specifically identifies that the ARRC and ISDA fallback language released on Oct. 9, 2020, must be used in order to meet the safe harbor.
The safe harbor created by the revenue procedure provides guidance for lenders of tax-exempt loans and IBOR-based financial instruments, including those hedging a variable rate tax-exempt loan. Modifications to such IBOR-based tax exempt loans and hedges with provisions that deviate from the ARRC or ISDA fallback language could cause a material modification to the underlying financial product. A material modification to a tax exempt loan could be treated as a reissuance under the federal income tax laws.
A reissuance would result in the modified loan being treated as a current refunding of the existing loan and consequently require, among other things, the filing of a new informational return with the IRS and the reintegration of any interest rate hedge agreement. A material modification to an integrated swap could cause the swap to be deemed terminated.
Lenders should consider requiring an opinion of bond counsel prior to an IBOR substitution to help ensure that such change will not adversely affect the tax-exempt status of the bonds.