TAX NEWS

October 30, 2019

2019 PRELIMINARY GUIDANCE PROVIDES RELIEF FOR CHANGES OF LIBOR INDICES OF OUTSTANDING DEBT AND DERIVATIVES
 

In anticipation of LIBOR phasing out after 2021, the Treasury Department has provided preliminary guidance (the “LIBOR Proposed Regulations”), allowing tax-exempt debts and derivatives, which pay interest based on a LIBOR-based variable rate, to be amended to substitute the LIBOR-based index with a substitute index (e.g., an index based on SOFR, which is the Secured Overnight Financing Rate published by Federal Reserve Bank of New York) without causing a tax event, so long as certain precautions are followed.  SOFR is expected to be the preferred alternative reference rate for U.S. dollar denominated bonds. 

Below is a summary of the new requirements, which are generally viewed favorably in that they allow for a one-time payment among parties, as well as substitutions that occur by way of amendments or actual exchanges of the original instrument for the new instrument, and any other associated alterations.  Any alterations or modifications that are made contemporaneously with these changes (e.g., increase in rate costs because of a financial deterioration of credit quality of the borrower) are outside the scope of these limited safe harbors, and will have to be reviewed to determine whether they will cause a tax event. 

For additional information and a more in-depth analysis of any particular fact situation, please contact Stefano Taverna or Hal Flanagan at (214) 754‑9200.

• The substitution of a LIBOR-based rate must occur with a “qualified rate” and be at “fair market value” (i.e., the substitute rate must be a substantial equivalent rate to the original LIBOR-based rate).
• A variety of rates (of the same currency) are deemed to qualify as a “qualified rate,” including SOFR, any other qualified floating rate (a.k.a. QFRs), or any alternative, substitute or successor rate selected, endorsed or recommended by the central bank, reserve bank, monetary authority or similar institution (including any committee or working group thereof) as a replacement for LIBOR.
• While any reasonable, consistently applied valuation method may be used to establish “fair market value” and while the value must take into account the value of any one-time payment that is made in connection with any alteration or modification of those instruments, the LIBOR Proposed Regulations provide two safe harbors to ensure that the LIBOR-based rate and the substitute rate are substantially equivalent.   
  • The first safe harbor is met if LIBOR’s historical averages over any period (not extending beyond 10 years prior to the modification) are within 25 basis points of the historical averages of the substitute rate.
  • The second safe harbor is met if the substitute rate is based on bona fide, arm’s length negotiations between unrelated third parties.

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This Tax Law Update was provided by McCall’s Tax Department.  It is intended for informational and marketing purposes only, and it is not to be construed as legal advice to any person or with regard to any matter.  While we hope that this Update is helpful to you, McCall is not responsible for any specific transaction or reporting position taken by any person after review hereof.