HMRC consults on tax impact of LIBOR reform

HMRC has set out its views on the main tax impacts for businesses as a result of reforms to the London Inter-bank Offered Rate (LIBOR) and other benchmark rates

LIBOR is a set of interest rate benchmarks based on the rates at which banks are willing to borrow wholesale unsecured funds. It is used in a large number of loans, derivatives and other financial instruments.

Publication of LIBOR is expected to cease after 2021 and parties to financial instruments will need to transition to using alternative reference rates.

In advance of this, it is likely that banks will contact affected parties to discuss their plans to either change the terms of existing financial instruments that use LIBOR, or replace them with new financial instruments that do not use LIBOR.

HMRC’s guidance summarises the legal and accounting issues and sets out HMRC’s views on the main tax implications for businesses from LIBOR reform.

In addition, the government is consulting to ensure that where tax legislation makes reference to LIBOR it continues to operate effectively.

This guidance applies to changes to financial instruments where they make amendments to replace the benchmark rate they refer to, or where they introduce or amend ‘fall-back’ provisions that determine how the contract should operate if the designated benchmark rate is permanently discontinued or otherwise cannot be used.

It also incidental amendments that are consequential to replacing the benchmark rate - for example making amendments to the loan margin or making additional payments to preserve the parties’ economic position

Contracts may be amended as a result of direct negotiation, changes in a bank’s standard terms and conditions, or through the parties adopting industry standard language.

If the terms of a financial instrument are amended, the way this is treated in the accounts could affect the tax treatment.

HMRC’s draft guidance coves this in detail, looking at specific provisions in the corporation tax rules for loan relationships and derivative contracts.

Where a financial instrument is taken out for the purposes of a trade or property business, the tax treatment will generally follow the accounting treatment in a similar way.

It should be noted that there are certain differences – for example, under the income tax rules payments will not be deductible if they are capital in nature (section 33 of the Income Tax (Trading and Other Income) Act 2005).

As a result, under both corporation tax and income tax rules, where the terms of a loan or derivative are amended to use a new interest rate, the tax treatment for the business will typically depend, in part, on the accounting treatment.

Where an amount is recognised in the income statement, this will typically be brought into account for tax purposes.

The intention of the parties, and how this is reflected in the legal documents, will be significant factors in determining whether the changes constitute an amendment to an existing financial instrument, or as the redemption and replacement of an existing financial instrument with a new financial instrument.

Where the parties agree to change the terms of the instrument for the purposes of responding to the withdrawal of LIBOR, HMRC would normally view this as a variation of the existing instrument. The amended contract should be regarded as the same contract and entered into at the same time as the original one.

The guidance also covers the impact of LIBOR reform with regard to the disregard regulations, grandfathering, making an additional payment, the double taxation treaty passport scheme, reporting requirements, transfer pricing, and company distributions.

The consultation is open until 28 May.

Draft guidance on the taxation impacts arising from the withdrawal of LIBOR and other benchmark rate reform

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