Get ready for the upcoming replacement of LIBOR

Get ready for the upcoming replacement of LIBOR

Wed 12 Feb 2020

LIBOR will cease to exist in 2021 as an interest rate index and is being replaced by the Sterling overnight index average (SONIA).  SONIA is a risk free rate (RFR).  RFRs are overnight rates, rather than term rates, and unlike LIBOR, they do not include a credit risk premium. A straight switch would therefore result in a value transfer between parties. To minimise this, an ‘adjusted RFR’, incorporating a spread, will be needed.  It does not look like the adjusting spread method has yet been finalised. 

Entities with, or holders of, financial instruments based on LIBOR should therefore be planning how to deal with the change, including the tax issues.  This note provides some further background on the possible tax issues and also on the management of the transition by the Bank of England.

There is a posting on the Mazars website on IBOR transition here and here.  For a further discussion on how to deal with the tax implications of the change for your business or circumstances, please get in touch with a member of the Mazars corporate tax or personal tax teams.

Possible tax issues

 The possible tax issues that could arise could include: 

  • For those subject to CGT, whether the switch from LIBOR will result in a disposal or not. See more commentary on this below.
  • For those subject to corporation tax, the tax issues are likely to be driven by the accounting changes, and whether (for example) the switch from LIBOR results in a de-recognition of an old loan note or derivative.  It may be important for companies with large loan portfolios or significant intercompany loans, to set up a process for reviewing the impact of the change on these loans.  Examples of some of the issues that might need to be considered could include:
    • A loan note accounted for on amortised cost that is de-recognised (and replaced with a new note using different terms) would result in a P&L movement of the difference between book value and fair value;
    • In view of the change in rate measure, it might be relevant to check whether any hedging relationships are affected.  An amendment to FRS102, has been made to maintain existing hedge accounting relationships during the period of uncertainty created by the reform.  The amendment is effective for accounting periods beginning on or after 1 January 2020, with earlier adoption permitted. 
    • It might be relevant to check whether any existing disregard regulations continue to apply or whether the disregard regulations need to be newly considered
    • It might be relevant to consider the transfer pricing implications of moving to the new interest rate measure and whether the new rate exceeds a commercial return – creating issues under the distribution rules, SD rules and equity holder status
    • It may also be relevant to consider the impact of the rate change on planning, projections and calculations relevant to the corporate interest restriction rules.

Disposals of securities for CGT purposes

If the terms of a financial instrument are altered to refer to SONIA (or some other interest rate measure), or the financial instrument is replaced altogether with a new instrument, it may be necessary to consider whether there has been a disposal for CGT purposes (the tax rules provide that there are certain circumstances when a transaction does not involve a CGT disposal).

Further background on the Bank of England’s management of the transition

The Bank of England has some information on the transition from LIBOR to sterling risk free rates here.   It is encouraging change to occur on 2 March 2020.

In managing the transition, a consultation document (the consultation closed on 6 February) has been issued on ‘credit adjustment spread methodology’.  That document includes the following comments:

“Working groups in the LIBOR currency jurisdictions have selected replacement rates for LIBOR; all have proposed alternative near risk-free rates (“RFRs”). These RFRs are not, however, economically equivalent to LIBOR. The relevant RFR rate needs to be adjusted to account for: (i) the fact that the RFR is an overnight rate and not a term rate; and (ii) the various premia included within LIBOR (i.e. a term liquidity premium and a bank credit risk element). In most cases, the RFRs are therefore expected to be lower than their LIBOR equivalent and consequently a credit adjustment spread may be required to minimise the economic impact of moving to these RFRs…..

…A significant majority of respondents to the ISDA Final Parameters Consultation felt that the most appropriate methodology for calculating a credit adjustment spread for fallbacks on cessation of LIBOR would be a historical median over a five-year lookback period…..”