ATO issues guidance following LIBOR abolition

The ATO has published guidance concerning the Inter-bank Offered Rate ('IBOR') reform announcement by the UK Financial Conduct Authority ('FCA').

Last month, the ATO issued guidance designed to assist businesses to understand the common tax implications to consider where changes are made to existing financial arrangements due to the IBOR reform, which most notably has resulted in the repeal of London Interbank Offered Rate ('LIBOR'). 

IBOR reform 

On 5 March 2021, the FCA formally announced that all LIBOR settings for all currencies will either cease to be published or no longer be representative, immediately after the following dates: 

• 31 December 2021 for all GBP, EUR, CHF, and JPY LIBOR settings in all tenors (overnight, one week, and one, two, three, six, and 12 months), and USD LIBOR one-week and two-month settings, and
• 30 June 2023 for USD LIBOR overnight and one, three, six, and 12-month settings.

Other local IBOR benchmarks such as EURIBOR and TIBOR are also being reformed either through improvements to their calculation methodology or replaced with alternate near RFRs.

Impact of the reform

This reform will have various tax implications and considerations for businesses that have entered financial arrangements that include IBOR-based payments references. Most obviously, it will not be possible to determine an IBOR-based floating interest rate given that such rates will not be published. It is expected that most financial arrangements that provide for IBOR-based payments will need to be modified to transition to an alternative near Risk-Free Rates ('RFRs'). Transitioning to RFRs is a complex process as RFRs are structurally different from IBORs.

The key IBOR affected is LIBOR. LIBOR has been the most common benchmark interest rate index used in variable-rate financing arrangements and has been used by banks globally when charging each other for short-term loans.

While the official rates for most IBOR settings will cease to be published from 31 December 2021, the FCA has confirmed that it will require the continued publication of certain LIBOR settings until the end of 2022 on a ‘synthetic’ basis. This will ensure minimal disruption for financial markets and for businesses who have entered into IBOR-based financial arrangements.

Amending or creating contracts

Modifications to the legal contracts of impacted IBOR-based financial arrangements can be done by:

• Replacement of the existing IBOR rate with an alternative RFR,
• Amendments to fallback clauses or introduction of new fallback clauses, and
• Other variations to contracts, such as additional payments or credit spread adjustments.

Following the choice of one of the above options contract law stipulates that the modification of a legal contract through an amendment may result in either the: 

• Continuation of the legal contract (a variation); or
• Creation of a new legal contract (a rescission) 

The ATO, in its guidance, specifies that it expects that amendments are, “likely to be characterised as a variation of the existing contract rather than the creation of a new legal contract”. Both parties will be required to agree to the amendment for the sole purpose of responding to the IBOR reform. 

Where a fallback provision is used according to the existing terms of the legal contract, the ATO notes that this should not be regarded as a variation to the contract. This means businesses will not be required to consider whether a new legal contract has been created.

Transfer pricing considerations 

Amendments to financial arrangements to transition from LIBOR may result in a transfer pricing benefit. 

To reduce the risk of a transfer pricing benefit arising, businesses should ensure that the amendment is: 

• inline with general commercial practices,
• is consistent with any other financing arrangements entered with third parties and other international related parties, and 
• is in line with the most recent recommendations published by the relevant industry and regulatory body.

Businesses should also document any amendments made to existing international related party financing arrangements in their contemporaneous transfer pricing documentation. 

Other Australian corporate tax considerations

Amendments to existing financial arrangements with a legal contract in place to transition from IBOR to an alternative RFR for the purpose of IBOR reform may trigger an assessable gain or deductible loss for income tax purposes. This will depend on whether the financial arrangement is subject to the Taxation of Financial Arrangements ('TOFA') regime and whether the amendment of the existing contract results in a variation. 

There are further considerations to be made under the TOFA regime if the amendment to the legal contract results in a rescission. However, the ATO notes this is unlikely under this scenario. 

In some limited circumstances, the tax impact of additional payments may need to be considered. Additional payments may be required where the amendment has been made and payment is required to preserve the parties’ economic positions. These additional payments could mean that certain financial arrangements would no longer receive withholding tax exemptions that had previously been received.

These payments may also result in an assessable gain or deducible loss or withholding tax liability. These determinations would be contingent on the nature and characterisation of these payments.

RSM Insights

Groups with financing positions with IBOR-based interest rates need to consider the necessary amendments to their agreements. Consideration should also be given to the method used to modify existing arrangements to transition to RFRs and how these amendments to these arrangements could be impacted by various tax implications discussed above

To the extent, the parties are simply amending the underlying reference rates in their financial arrangements due to the IBOR reform (for example, swapping out LIBOR for SONIA or AONIA) this is more likely than not to be considered an amendment of an existing contract (continuation) rather than the creation of a new contract.

Such arrangements are unlikely to give rise to a transfer pricing benefit to the extent the transition follows recommendations published by relevant industry and regulatory bodies, though care should be taken and any changes should be reviewed from a tax and transfer pricing perspective. 

If you require assistance in relation to the LIBOR abolition, please contact your local RSM tax advisor.