Guidance on the Transition From Interbank Offered Rates to Other Reference Rates, 166-182 [2021-28452]

Agencies

• Internal Revenue Service
• DEPARTMENT OF THE TREASURY

[Federal Register Volume 87, Number 2 (Tuesday, January 4, 2022)]
[Rules and Regulations]
[Pages 166-182]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2021-28452]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 1 and 301

[TD 9961]
RIN 1545-BO91


Guidance on the Transition From Interbank Offered Rates to Other 
Reference Rates

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

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SUMMARY: This document contains final regulations that provide guidance 
on the tax consequences of the transition away from the use of certain 
interbank offered rates in debt instruments, derivative contracts, and 
other contracts. The final regulations are necessary to address the 
possibility that a modification of the terms of a contract to replace 
such an interbank offered rate with a new reference rate could result 
in the realization of income, deduction, gain, or loss for Federal 
income tax purposes or could have other tax consequences. The final 
regulations will affect parties to contracts that reference certain 
interbank offered rates.

DATES: 
    Effective date: These final regulations are effective on March 7, 
2022.
    Applicability date: For dates of applicability, see Sec. Sec.  
1.860A-1(b)(7), 1.1001-6(k), and 1.1275-2(m)(5).

FOR FURTHER INFORMATION CONTACT: Spence Hanemann at (202) 317-4554 (not 
a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

    This document contains amendments to the Income Tax Regulations (26 
CFR part 1) under sections 860A, 860G, 1001, 1271, 1275, and 7701(l) of 
the Internal Revenue Code (Code) and to the Procedure and 
Administration Regulations (26 CFR part 301) under section 7701 of the 
Code.

1. Discontinuation of LIBOR and Tax Implications

    On July 27, 2017, the Financial Conduct Authority, the United 
Kingdom regulator tasked with overseeing the London Interbank Offered 
Rate (LIBOR), announced that publication of all currency and term 
variants of LIBOR, including U.S.-dollar LIBOR (USD LIBOR), may cease 
after the end of 2021. The administrator of LIBOR, the ICE Benchmark 
Administration, announced on March 5, 2021, that publication of 
overnight, one-month, three-month, six-month, and 12-month USD LIBOR 
will cease immediately following the LIBOR publication on June 30, 
2023, and that publication of all other currency and tenor variants of 
LIBOR will cease immediately following the LIBOR publication on 
December 31, 2021.
    On September 29, 2021, the Financial Conduct Authority announced 
that it will compel the ICE Benchmark Administration to continue to 
publish one-month, three-month, and six-month sterling LIBOR and 
Japanese yen LIBOR after December 31, 2021, using a ``synthetic'' 
methodology that is not based on panel bank contributions (synthetic 
GBP LIBORs and synthetic JPY LIBORs, respectively). The Financial 
Conduct Authority has indicated that it may also require the ICE 
Benchmark Administration to publish one-month, three-month, and six-
month USD LIBOR after June 30, 2023, using a similar synthetic 
methodology (synthetic USD LIBORs). However, these synthetic GBP 
LIBORs, synthetic JPY LIBORs, and synthetic USD LIBORs are expected to 
be published for a limited period of time.
    Various tax issues may arise when taxpayers modify contracts in 
anticipation of the discontinuation of LIBOR or another interbank 
offered rate (IBOR). For example, such a modification may be treated as 
an exchange of property for other property differing materially in kind 
or extent for purposes of Sec.  1.1001-1(a), giving rise to gain or 
loss. Such a modification may also have consequences under the rules 
for integrated transactions and hedging transactions, withholding under 
chapter 4 of the Code, fast-pay stock, investment trusts, original 
issue discount, and real estate mortgage investment conduits (REMICs). 
To minimize potential market disruption and to facilitate an orderly 
transition in connection with the discontinuation of LIBOR and other 
IBORs, the Treasury Department and the IRS published proposed 
regulations (REG-118784-18) in the Federal Register (84 FR 54068) on 
October 9, 2019 (Proposed Regulations). The Proposed Regulations 
generally provide that modifying a debt instrument, derivative, or 
other contract in anticipation of an elimination of an IBOR is not 
treated as an exchange of property for other property differing 
materially in kind or extent for purposes of Sec.  1.1001-1(a). The 
Proposed Regulations also adjust other tax rules to minimize the 
collateral consequences of the transition away from IBORs.

2. Rev. Proc. 2020-44

    The Alternative Reference Rates Committee (ARRC), whose ex officio 
members include the Treasury Department, was convened by the Board of 
Governors of the Federal Reserve System and the Federal Reserve Bank of 
New York in 2014. To support the transition away from USD LIBOR, the 
ARRC has published recommended fallback language for inclusion in the 
terms of certain cash products, such as syndicated loans and 
securitizations. The ARRC has also been actively engaged in work led by 
the International Swaps and Derivatives Association (ISDA) to ensure 
that the contractual fallback provisions in derivative contracts are 
sufficiently robust to prevent serious market disruptions when LIBOR is 
discontinued or becomes unreliable. To that end, ISDA developed the 
ISDA 2020 IBOR Fallbacks Protocol by which the parties to certain 
derivative contracts can incorporate certain improved fallback 
provisions into the terms of those contracts.
    On October 9, 2020, the Treasury Department and the IRS released 
Rev. Proc. 2020-44, 2020-45 I.R.B. 991, in advance of finalizing the 
Proposed Regulations to support the adoption of the ARRC's recommended 
fallback provisions and the ISDA 2020 IBOR Fallbacks Protocol. Rev. 
Proc. 2020-44 provides that a modification within the scope of the 
revenue procedure is not treated as an exchange of property for

[[Page 167]]

other property differing materially in kind or extent for purposes of 
Sec.  1.1001-1(a). In addition, Rev. Proc. 2020-44 generally provides 
that a modification within the scope of the revenue procedure will not 
result in legging out of an integrated transaction or terminating 
either leg of a hedging transaction.

3. The Final Regulations

    The Treasury Department and the IRS received public comments on the 
Proposed Regulations from eight commenters. Copies of these comments 
are available for public inspection at https://www.regulations.gov or 
upon request. No public hearing was requested, and none was held. After 
consideration of the public comments, the Treasury Department and the 
IRS adopt the Proposed Regulations as amended by this Treasury decision 
(Final Regulations).

Summary of Comments and Explanation of Revisions

    The Final Regulations are intended to provide special rules to help 
taxpayers adjust to the discontinuation of certain widely used interest 
rate benchmarks. To achieve this purpose, the Treasury Department and 
the IRS have concluded that it is appropriate in this context to depart 
from the ordinary tax rules to the degree and in the manner provided in 
the Final Regulations. One commenter recommended that the Treasury 
Department and the IRS supplement the rules in the Final Regulations 
with ``rules of construction'' based on the reasonableness of 
taxpayers' actions. The Treasury Department and the IRS decline to 
adopt this comment because such a principles-based rule would blur the 
carefully circumscribed degree and manner in which the Final 
Regulations authorize taxpayers to depart from the ordinary tax rules.
    Although the Final Regulations and Proposed Regulations share many 
of the same fundamental rules, the structure of Sec.  1.1001-6 in the 
Final Regulations differs from that of the Proposed Regulations. These 
structural changes are primarily intended to simplify the operative 
rules, which are in Sec.  1.1001-6(b) through (g) of the Final 
Regulations. For example, while the Proposed Regulations separately 
state the rules for debt and non-debt contracts, the Final Regulations 
provide a single set of rules for all contracts. The Final Regulations 
define contract broadly to include not only debt instruments and 
derivative contracts but also insurance contracts, stock, leases, and 
other contractual relationships.
    The Final Regulations also make use of defined terms, located in 
Sec.  1.1001-6(h), to streamline references to concepts that are 
frequently used in the operative rules in Sec.  1.1001-6(b) through 
(g). In particular, the defined term ``covered modification'' is the 
cornerstone of these rules and serves to restructure several of the 
fundamental rules set forth in the Proposed Regulations. For example, 
Sec.  1.1001-6 of the Proposed Regulations generally provides certain 
beneficial tax consequences when the parties to a contract modify the 
contract to replace an IBOR-based rate with a ``qualified rate'' and 
make certain ``associated modifications,'' which may include a ``one-
time payment.'' The Final Regulations unite these various elements of 
the Proposed Regulations (that is, modification of a contract, an IBOR-
based rate, a qualified rate, associated modifications, and a one-time 
payment) in the single defined term ``covered modification.''

1. Treatment Under Section 1001

    Section 1.1001-6(a) of the Proposed Regulations generally provides 
rules for applying section 1001 to a contract that is modified to 
replace an IBOR-based rate or IBOR-based fallback provisions or to add 
or amend fallback provisions that would replace an IBOR-based rate. 
Section 1.1001-6(a) of the Proposed Regulations generally provides that 
such a modification is not treated as an exchange of property under 
section 1001 and extends this treatment to any reasonably necessary 
conforming modifications. When modifications that qualify for this 
special treatment under proposed Sec.  1.1001-6(a) occur 
contemporaneously with modifications that do not qualify, the non-
qualifying modifications are subject to the ordinary rules under Sec.  
1.1001-1(a) or Sec.  1.1001-3 and the modifications that qualify for 
special treatment under proposed Sec.  1.1001-6(a) are treated as part 
of the existing terms of the contract. Section 1.1001-6(b) of the Final 
Regulations provides similar rules but makes use of the defined terms 
``covered modification'' and ``noncovered modification.''
a. Treatment of Covered and Noncovered Modifications
    Under Sec.  1.1001-6(b)(1) of the Final Regulations, a covered 
modification of a contract is not treated as an exchange of property 
for other property differing materially in kind or in extent for 
purposes of Sec.  1.1001-1(a). Consequently, in the case of a debt 
instrument, a covered modification to which Sec.  1.1001-6(b)(1) 
applies is not treated as a significant modification for purposes of 
Sec.  1.1001-3. As defined in Sec.  1.1001-6(h)(1) of the Final 
Regulations, a covered modification is generally comprised of four 
elements: (1) A contract with an operative rate or fallback provision 
that references a discontinued IBOR; (2) a modification of that 
contract (a) to replace an operative rate that refers to a discontinued 
IBOR with a qualified rate and, if the parties so choose, to add an 
obligation for one party to make a qualified one-time payment, (b) to 
include a qualified rate as a fallback to an operative rate that refers 
to a discontinued IBOR, or (c) to replace a fallback rate that refers 
to a discontinued IBOR with a qualified rate; (3) any associated 
modifications with respect to those modifications of the operative rate 
or fallback provisions; and (4) satisfaction of rules in Sec.  1.1001-
6(j) of the Final Regulations that exclude certain modifications from 
the definition of covered modification. The defined terms 
``discontinued IBOR,'' ``qualified rate,'' ``qualified one-time 
payment,'' and ``associated modification'' and the rules in Sec.  
1.1001-6(j) of the Final Regulations that exclude certain modifications 
are discussed in more detail in the sections of this preamble entitled 
Discontinued IBOR, Qualified rate, Qualified one-time payments, 
Associated modifications, and Fair market value requirement and 
excluded modifications, respectively. A modification described in 
section 4.02 of Rev. Proc. 2020-44, as supplemented by any guidance 
that may be published in the Internal Revenue Bulletin, is also treated 
as a covered modification. Rev. Proc. 2020-44 is discussed in more 
detail in the section of this preamble entitled Rev. Proc. 2020-44. For 
purposes of the definition of a covered modification, the term 
``modification'' is broadly construed to include any modification, 
regardless of its form. For example, a holding corporation that issued 
preferred stock may modify that stock for purposes of the Final 
Regulations by means of an exchange offer conducted by the 
corporation's subsidiary. The term also includes any modification 
regardless of whether the modification is evidenced by an express 
agreement (oral or written), conduct of the parties, or otherwise. For 
example, any agreement to make additional payments with respect to a 
contract is a modification of that contract, regardless of whether the 
parties memorialize the obligation to make those payments in an 
amendment to the original contract or in a new, standalone contract.

[[Page 168]]

    Although Sec.  1.1001-6(b)(1) of the Final Regulations generally 
provides that a covered modification of a contract is not treated as an 
exchange of property for other property differing materially in kind or 
in extent for purposes of Sec.  1.1001-1(a), whether a noncovered 
modification that occurs contemporaneously with the covered 
modification is an exchange of property for other property differing 
materially in kind or in extent is determined under the ordinary rules 
in Sec.  1.1001-1(a) or Sec.  1.1001-3. The Final Regulations define a 
noncovered modification as any modification or portion of a 
modification of a contract that is not a covered modification. Two 
commenters asked whether pairing a modification that would otherwise 
qualify for beneficial treatment under the Proposed Regulations with a 
contemporaneous modification that does not so qualify prevents both 
modifications from benefitting from the Proposed Regulations. The 
reference to a ``portion of a modification'' in the definitions of 
covered modification and noncovered modification in the Final 
Regulations indicates that a modification is a noncovered modification 
only to the extent that it fails to be a covered modification.
    Two commenters requested that the Treasury Department and the IRS 
clarify whether, following a covered modification by which the parties 
add or amend fallback provisions, the change to the terms of the 
contract that results from the activation of the new fallback 
provisions must be tested separately at the time of activation to 
determine whether that change is an exchange of property for other 
property differing materially in kind or in extent for purposes of 
Sec.  1.1001-1(a). As is ordinarily the case, a change to the terms of 
the contract that results from the activation of a fallback provision 
must be tested at the time of activation to determine whether that 
change results in such an exchange under Sec.  1.1001-1(a). If the 
change resulting from the activation of a fallback is a covered 
modification under Sec.  1.1001-6(h)(1) of the Final Regulations, then 
the special rules provided in the Final Regulations for covered 
modifications apply to that change. Otherwise, whether that change is 
an exchange of property for other property differing materially in kind 
or in extent is generally determined under Sec.  1.1001-3 for debt 
instruments and under Sec.  1.1001-1(a) for other kinds of contracts.
b. Discontinued IBOR
    Section 1.1001-6(h)(4) of the Final Regulations defines 
``discontinued IBOR,'' a term not used in the Proposed Regulations. 
Sections 1.860G-1(e) and 1.1275-2(m) of the Final Regulations also 
incorporate this definition. Under this new definition, a discontinued 
IBOR is generally an IBOR that will be discontinued, and an IBOR ceases 
to be a discontinued IBOR a year after the IBOR's discontinuation. The 
purpose of this new definition is to tailor the relief provided in the 
Final Regulations to better match the problem that the Final 
Regulations are intended to address.
    One commenter requested that the Final Regulations apply when the 
parties to a contract modify the terms of the contract after the 
existing fallback provisions have already replaced all references to 
the IBOR with another rate. The commenter noted that, in the case of 
some widely held debt instruments, securing the consent of enough 
holders to modify the terms of the debt instrument may delay the 
modification so that the existing fallback provisions are triggered 
before the modification is complete. In such cases, the Proposed 
Regulations would not apply to the modification because the qualified 
rate would not be replacing an IBOR-based rate. The purpose of the 
Final Regulations is to facilitate the transition away from 
discontinued IBORs in order to avoid the market disruption that may 
occur if parties to contracts referencing discontinued IBORs fail to 
transition before the discontinued IBOR ceases. The change suggested by 
the commenter is not necessary to achieve this purpose. Moreover, the 
discontinuation of the most commonly used tenors of USD LIBOR has been 
deferred until June 30, 2023, giving parties to contracts such as those 
described by the commenter an additional 18 months to act. Accordingly, 
the Final Regulations do not adopt this comment.
    As discussed in the section of this preamble entitled 
Discontinuation of LIBOR and Tax Implications, the ICE Benchmark 
Administration will continue to publish synthetic GBP LIBORs and 
synthetic JPY LIBORs for a limited time after December 31, 2021, and 
may publish synthetic USD LIBORs for a limited time after June 30, 
2023. The Treasury Department and the IRS have determined that, for 
purposes of the Final Regulations, these synthetic LIBORs are a 
continuation of the currency and tenor variant of LIBOR that they 
succeed. Thus, for example, three-month sterling LIBOR became a 
discontinued IBOR on March 5, 2021, the date on which the ICE Benchmark 
Administration announced that it would permanently cease to publish 
three-month sterling LIBOR, and will cease to be a discontinued IBOR 
one year after the date on which the ICE Benchmark Administration 
ceases to publish the three-month tenor of synthetic GBP LIBOR.
c. Qualified Rate
    The definition of ``qualified rate'' in Sec.  1.1001-6(b) of the 
Proposed Regulations generally includes three elements: (1) The 
putative qualified rate must appear on a list of rates eligible to be a 
qualified rate in Sec.  1.1001-6(b)(1); (2) the fair market values of 
the contract before and after the modification involving the putative 
qualified rate must be substantially equivalent under Sec.  1.1001-
6(b)(2); and (3) the interest rate benchmark to which the putative 
qualified rate refers and the relevant IBOR generally must be based on 
the same currency under Sec.  1.1001-6(b)(3). The fair market value 
requirement is addressed in more detail in the section of this preamble 
entitled Fair market value requirement and excluded modifications.
    One commenter recommended streamlining the list of rates that are 
eligible to be a ``qualified rate'' in Sec.  1.1001-6(b)(1) of the 
Proposed Regulations. The commenter pointed out that Sec.  1.1001-
6(b)(1)(x) of the Proposed Regulations generally includes qualified 
floating rates without regard to the limitations on multiples and that 
the interest rate benchmarks listed in Sec.  1.1001-6(b)(1)(i) through 
(viii) of the Proposed Regulations are merely examples of qualified 
floating rates. In response, the Treasury Department and the IRS have 
merged Sec.  1.1001-6(b)(1)(i) through (viii) and (x) of the Proposed 
Regulations into a single entry in Sec.  1.1001-6(h)(3)(ii)(A) of the 
Final Regulations, which includes a non-exclusive list of rates that 
are generally qualified floating rates, such as the Secured Overnight 
Financing Rate published by the Federal Reserve Bank of New York 
(SOFR), the Sterling Overnight Index Average, the Tokyo Overnight 
Average Rate, the Swiss Average Rate Overnight, and the euro short-term 
rate administered by the European Central Bank.
    This commenter also suggested that Sec.  1.1001-6(b)(1)(xi) of the 
Proposed Regulations, which describes any rate determined by reference 
to another rate included in the list of eligible rates, is unnecessary 
because any rate described in that paragraph is also described in Sec.  
1.1001-6(b)(1)(x) of the Proposed Regulations, which is any qualified

[[Page 169]]

floating rate without regard to the limitations on multiples. However, 
certain IBOR-based objective rates (as defined in Sec.  1.1275-5(c)) 
and certain IBOR-based rates on contingent payment debt instruments 
(within the meaning of Sec.  1.1275-4) may not be described in Sec.  
1.1001-6(b)(1)(x) of the Proposed Regulations. Accordingly, the Final 
Regulations do not adopt this comment and retain both Sec.  1.1001-
6(b)(1)(x) and (xi) of the Proposed Regulations in the list of eligible 
rates at Sec.  1.1001-6(h)(3)(ii)(A) and (D) of the Final Regulations, 
respectively.
    Other commenters suggested that the list of rates that are eligible 
to be qualified rates in the Proposed Regulations be expanded to 
include any rate identified by the ARRC or ISDA as a replacement for an 
IBOR. The Treasury Department and the IRS have concluded that allowing 
any purely private organizations the authority to add to the list of 
rates eligible to be qualified rates would be inconsistent with the 
carefully circumscribed degree and manner in which the Final 
Regulations authorize taxpayers to depart from the ordinary tax rules. 
Accordingly, the Final Regulations extend such authority only to the 
ARRC and only for as long as the Federal Reserve Bank of New York 
continues to be an ex officio member of the ARRC.
    One commenter recommended that the currency element of the 
definition of qualified rate in Sec.  1.1001-6(b)(3) of the Proposed 
Regulations be removed. After stating that a qualified rate under the 
Proposed Regulations must generally be a qualified floating rate, the 
commenter reasoned that the currency requirement in the definition of 
qualified rate is unnecessary because that requirement is already built 
into the definition of qualified floating rate under Sec.  1.1275-5(b). 
The Final Regulations do not adopt this comment because a qualified 
rate under the Final Regulations is not required to be a qualified 
floating rate. For example, an objective rate based on a qualified 
floating rate may be described in Sec.  1.1001-6(h)(3)(ii)(D) of the 
Final Regulations but not in Sec.  1.1001-6(h)(3)(ii)(A) of the Final 
Regulations. Also, although the currency requirements in Sec.  1.1001-
6(h)(3)(i) of the Final Regulations and Sec.  1.1275-5(b) may overlap 
in many cases, these requirements are not identical. The currency 
requirement for qualified rates in the Final Regulations requires that 
the discontinued IBOR and the interest rate benchmark included in the 
qualified rate be based on the same currency, whereas the currency 
requirement for qualified floating rates in Sec.  1.1275-5(b) requires 
that the currency on which the qualified floating rate is based match 
the currency in which the debt instrument is denominated.
    The definition of qualified rate has also been amended in the Final 
Regulations in response to public comments that identify gaps in how 
the definition of qualified rate in the Proposed Regulations applies to 
covered modifications that involve the addition or amendment of 
fallback provisions. In particular, commenters asked how the definition 
of qualified rate applies when a contract is modified to include a 
waterfall of fallback rates, the individual tiers of which may not 
independently satisfy the definition of qualified rate. Commenters also 
asked how the definition of qualified rate applies to a fallback rate 
that will be determined on the date that the fallback rate is triggered 
and cannot be determined on the date of the modification by which that 
fallback rate is added to the contract.
    The Final Regulations address these comments by providing a series 
of rules in sect; 1.1001-6(h)(3)(i) and (iii) for determining whether a 
fallback rate or a collection of fallback rates meet the definition of 
a qualified rate. Section 1.1001-6(h)(3)(i) of the Final Regulations 
provides that a single qualified rate may be comprised of more than one 
fallback rate, such as when the parties add a fallback waterfall. In 
other words, this rule treats a waterfall of fallbacks as a unit and 
evaluates that unit to determine if it is a qualified rate. Thus, if 
the waterfall is designed so that each tier replaces the preceding tier 
when triggered (for example, when USD LIBOR ceases, USD LIBOR is 
replaced by the first tier of the waterfall and, if the first tier of 
the waterfall ceases, that first tier is replaced by the second tier), 
the entire waterfall is treated as a fallback to a discontinued IBOR 
even though, as a technical matter, only the first tier of the 
waterfall is a fallback to the discontinued IBOR. Section 1.1001-
6(h)(3)(iii)(A) of the Final Regulations generally provides that, when 
a collection of fallback rates is added to the contract (for example, a 
fallback waterfall), that collection of fallback rates is a qualified 
rate only if each individual fallback rate in the collection meets the 
requirements to be a qualified rate. Sections 1.1001-6(h)(3)(iii)(B) 
and (C) of the Final Regulations apply for purposes of determining 
whether an individual fallback rate (regardless of whether that 
fallback rate was added to the contract individually or the fallback 
rate was added as a collection of fallback rates and is being tested 
individually under Sec.  1.1001-6(h)(3)(iii)(A) of the Final 
Regulations) meets the requirements to be a qualified rate. Under Sec.  
1.1001-6(h)(3)(iii)(B) of the Final Regulations, a fallback rate is 
treated as not meeting the requirements to be a qualified rate if the 
contractual terms that comprise the fallback rate do not ensure at the 
time of the modification that the fallback rate will meet the 
requirements to be a qualified rate identified in the first sentence of 
Sec.  1.1001-6(h)(3)(i) of the Final Regulations when the fallback rate 
is triggered. Under Sec.  1.1001-6(h)(3)(iii)(C) of the Final 
Regulations, a fallback rate is treated as meeting the requirements to 
be a qualified rate if the likelihood that it will ever be triggered is 
remote. If Sec.  1.1001-6(h)(3)(iii)(B) and (C) of the Final 
Regulations both apply to a given fallback rate, the rule in Sec.  
1.1001-6(h)(3)(iii)(C) takes priority over the rule in Sec.  1.1001-
6(h)(3)(iii)(B). Examples in Sec.  1.1001-6(h)(3)(iv) of the Final 
Regulations illustrate the operation of these rules for fallback rates.
d. Associated Modifications
    The Proposed Regulations generally define an associated 
modification as a modification that is both associated with the 
replacement of an IBOR-based rate or the inclusion of fallbacks to an 
IBOR-based rate and that is reasonably necessary to adopt or to 
implement that replacement or inclusion. Section 1.1001-6(h)(5) of the 
Final Regulations generally defines an associated modification 
similarly but eliminates the requirement that an associated 
modification be ``associated with'' such a replacement or inclusion 
because any modification that is reasonably necessary to adopt or to 
implement the replacement or inclusion is necessarily associated with 
that replacement or inclusion.
    The definition of ``associated modification'' in the Proposed 
Regulations also includes a ``one-time payment,'' which is generally 
defined as a payment to offset the change in value of the contract that 
results from replacing an IBOR-based rate with a qualified rate. One 
commenter asked whether certain cash payments can qualify as associated 
modifications even if they do not qualify as one-time payments. For 
example, if the parties to an interest rate swap agree to replace USD 
LIBOR with a replacement rate comprised of a compounded average of SOFR 
(computed in arrears using a two-day observation period shift without 
payment lag) and a fixed adjustment spread, one party might also agree 
to make an incidental cash payment to compensate the counterparty for 
small valuation differences between the pre-

[[Page 170]]

modification LIBOR-based contract and the post-modification SOFR-based 
contract, such as the valuation differences resulting from the 
difference in observation period. The Treasury Department and the IRS 
have concluded that including such limited payments within the 
definition of an associated modification would further the policy goal 
of the Final Regulations to facilitate the transition away from 
discontinued IBORs. Accordingly, the definition of ``associated 
modification'' in Sec.  1.1001-6(h)(5) of the Final Regulations 
includes an incidental cash payment intended to compensate a 
counterparty for small valuation differences resulting from a 
modification of the administrative terms of a contract, such as the 
valuation differences resulting from a change in observation period. 
The Treasury Department and the IRS caution, however, that a payment of 
an amount that is not incidental cannot qualify as an associated 
modification.
e. Qualified One-Time Payments
    The Proposed Regulations provide that a ``one-time payment,'' 
generally defined as a payment to offset the change in value of the 
contract that results from replacing an IBOR-based rate with a 
qualified rate, may be an associated modification. To improve 
readability and clarity, the Final Regulations redesignate ``one-time 
payments'' as ``qualified one-time payments'' and define the new term 
in a standalone definition rather than as a kind of associated 
modification.
    Commenters asked whether the Proposed Regulations cap the amount of 
a one-time payment and described certain abuses that may result if the 
amount of the payment is not limited in some way. To clarify the intent 
of the Proposed Regulations and to prevent excessive payments from 
satisfying the definition of qualified one-time payments, the Final 
Regulations generally limit a qualified one-time payment to the amount 
intended to compensate for the basis difference between the 
discontinued IBOR and the interest rate benchmark to which the 
qualified rate refers. Any portion in excess of that cap is a 
noncovered modification.
f. Fair Market Value Requirement and Excluded Modifications
    The Proposed Regulations generally require that the fair market 
value of the modified contract be substantially equivalent before and 
after the modification. The Proposed Regulations provide two safe 
harbors to the fair market value requirement: The historical average 
safe harbor and the arm's length safe harbor. Under the historical 
average safe harbor, the fair market value requirement is generally 
satisfied if, on the date of the modification, the historical average 
of the IBOR-based rate is within 25 basis points of the historical 
average of the putative qualified rate. To qualify for the arm's length 
safe harbor, the parties to the contract generally must not be related 
under Sec.  267(b) or Sec.  707(b)(1), must conduct bona fide, arm's 
length negotiations, and must determine based on those negotiations 
that the fair market value requirement is satisfied. The Treasury 
Department and the IRS received many public comments identifying 
practical problems and technical issues with the fair market value 
requirement and its two safe harbors. In response to these public 
comments, the Treasury Department and the IRS have replaced the fair 
market value requirement with rules that describe specific 
modifications (the excluded modifications) and exclude those 
modifications from the definition of covered modification. These 
excluded modifications are described in Sec.  1.1001-6(j)(1) through 
(5) of the Final Regulations.
    One significant purpose of the fair market value requirement in the 
Proposed Regulations is to ensure that the modifications to the cash 
flows of an IBOR-referencing contract are intended to address the 
replacement of the IBOR-based rate in the contract. Because the 
excluded modifications replace the fair market value requirement, each 
of the excluded modifications described in Sec.  1.1001-6(j)(1) through 
(5) of the Final Regulations involves modifying the contract in a way 
that changes the amount or timing of contractual cash flows.
    In addition to a change in cash flows, each of the excluded 
modifications also describes a particular purpose or intent of the 
parties making the modification. Section 1.1001-6(j)(1) of the Final 
Regulations generally describes a situation in which the parties to a 
contract change the contractual cash flows to induce one or more of the 
parties to perform any act necessary to consent to a covered 
modification of the contract. Example 3 in Sec.  1.1001-6(j)(6)(iii) 
illustrates the operation of Sec.  1.1001-6(j)(1). Section 1.1001-
6(j)(2) of the Final Regulations generally describes a situation in 
which the parties to a contract agree to a contemporaneous noncovered 
modification of that contract that does not necessarily change 
contractual cash flows and, in consideration for that change, also 
agree to change contractual cash flows. Example 5 in Sec.  1.1001-
6(j)(6)(v) illustrates the operation of Sec.  1.1001-6(j)(2). Section 
1.1001-6(j)(3) of the Final Regulations generally describes a situation 
in which one party to a contract is experiencing financial distress and 
another party either makes a concession to or secures a concession from 
the distressed party in the form of a change in contractual cash flows. 
Example 6 in Sec.  1.1001-6(j)(6)(vi) illustrates the operation of 
Sec.  1.1001-6(j)(3). Section 1.1001-6(j)(4) of the Final Regulations 
generally describes a situation in which the parties to a contract 
agree to change contractual cash flows on that contract as 
consideration for some extra-contractual arrangement. Example 7 in 
Sec.  1.1001-6(j)(6)(vii) illustrates the operation of Sec.  1.1001-
6(j)(4). Section 1.1001-6(j)(4) of the Final Regulations also includes 
a special rule that applies when the parties make an aggregate 
qualified one-time payment on a portfolio of modified contracts. In 
that case, the portion of the qualified one-time payment allocable to 
any one contract in the portfolio is treated as not intended to 
compensate for any changes in rights or obligations under any other 
contract in the portfolio.
    In Sec.  1.1001-6(j)(5) of the Final Regulations, the Treasury 
Department and the IRS reserve the authority to expand this list of 
excluded modifications in guidance published in the Internal Revenue 
Bulletin. To exercise this authority, the Treasury Department and the 
IRS must conclude that the modification to be described in such 
guidance has a principal purpose of achieving a result that is 
unreasonable in light of the purpose of Sec.  1.1001-6. The Treasury 
Department and the IRS have concluded that this reservation of 
authority is necessary to prevent any unforeseen abuses of the 
significant flexibility granted to taxpayers in the Final Regulations. 
However, the Treasury Department and the IRS anticipate that any such 
guidance would be prospective in effect.
g. Rev. Proc. 2020-44
    In Rev. Proc. 2020-44, the Treasury Department and the IRS provided 
rules that overlap with certain of the rules in the Final Regulations. 
Like Sec.  1.1001-6(b)(1) of the Final Regulations, section 5.01 of 
Rev. Proc. 2020-44 provides that a modification within the scope of the 
revenue procedure is not treated as an exchange of property for other 
property differing materially in kind or extent for purposes of Sec.  
1.1001-1(a). And like Sec.  1.1001-6(c)(1)(iii) and (c)(2) of the Final 
Regulations, section 5.02 of Rev. Proc. 2020-44 generally provides that 
a modification within the scope of the

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revenue procedure will not result in legging out of an integrated 
transaction or terminating either leg of a hedging transaction. Section 
4.02 of Rev. Proc. 2020-44 generally limits the scope of the revenue 
procedure to modifications to a contract to incorporate certain 
fallback provisions published by the ARRC or ISDA, labeled the ``ARRC 
Fallbacks'' and the ``ISDA Fallbacks'' by the revenue procedure. The 
parties modifying a contract under Rev. Proc. 2020-44 may also deviate 
in certain limited ways from the ARRC and ISDA Fallbacks. The Treasury 
Department and the IRS noted that the scope of the revenue procedure 
may be expanded in subsequent guidance published in the Internal 
Revenue Bulletin to address developments in the transition away from 
IBORs. The revenue procedure applies to modifications that occur on or 
after October 9, 2020, and before January 1, 2023, although the parties 
to a contract may rely on the revenue procedure for modifications that 
occur before October 9, 2020.
    In the definition of covered modification in Sec.  1.1001-6(h)(1), 
the Final Regulations generally provide that a modification described 
in section 4.02 of Rev. Proc. 2020-44 is treated as a covered 
modification. A modification described in section 4.02 of Rev. Proc. 
2020-44 is treated as a covered modification even if the revenue 
procedure does not apply to that modification, for example, because the 
modification occurs after the revenue procedure's sunset date of 
December 31, 2022. The effect of this provision is that the rules in 
Sec. Sec.  1.1001-6(b) through (g) and 1.860G-1(e), which rely on the 
definition of covered modification in Sec.  1.1001-6(h)(1), apply to 
modifications described in section 4.02 of Rev. Proc. 2020-44. Because 
of the substantive overlap between the rules in Sec.  1.1001-6(b) and 
(c) of the Final Regulations and the rules in section 5 of Rev. Proc. 
2020-44, it is possible for a single modification to be subject to both 
sets of rules. As a practical matter, however, the rules in Sec.  
1.1001-6(b) and (c) of the Final Regulations are consistent with the 
rules in section 5 of Rev. Proc. 2020-44, so no conflict is expected to 
arise.
    Prior to the release of Rev. Proc. 2020-44, several commenters 
recommended that the Final Regulations accommodate the fallback 
provisions published by the ARRC and ISDA. For example, one commenter 
recommended that the Final Regulations provide that a modification to 
incorporate the ARRC's or ISDA's fallback provisions or fallback 
provisions substantially similar to the ARRC's or ISDA's fallback 
provisions is not an exchange of property under section 1001. Rev. 
Proc. 2020-44 and its incorporation into the definition of covered 
modification in the Final Regulations address these comments.

2. Integrated Transactions and Hedging Transactions

    Section 1.1001-6(c) of the Proposed Regulations generally provides 
that the modification of a contract to replace an IBOR-based rate with 
a qualified rate is not treated as legging out of a transaction 
integrated under Sec.  1.1275-6, Sec.  1.988-5(a), or Sec.  1.148-4(h), 
provided that the components of the transaction continue to qualify for 
integration after the modification. That section also generally 
provides that the modification of a contract to replace an IBOR-based 
rate with a qualified rate is not treated as a disposition or 
termination of either leg of a hedging transaction under Sec.  1.446-
4(e)(6). One commenter stated that, because Sec.  1.446-4 refers to 
Sec.  1.1221-2(b) for the definition of ``hedging transaction'' and 
because a hedging transaction and the hedged item must be identified as 
provided in Sec.  1.1221-2(f), the inclusion in the Proposed 
Regulations of a rule for Sec.  1.446-4 may justify a negative 
inference that a similar rule is required to avoid reidentification 
under Sec.  1.1221-2(f). The Treasury Department and the IRS have 
concluded that Sec.  1.1001-6(b)(1) of the Final Regulations, which 
provides that a covered modification of either a hedging transaction or 
the hedged item is not treated as an exchange of property for other 
property differing materially in kind or in extent for purposes of 
Sec.  1.1001-1(a), is sufficient to ensure that neither the hedging 
transaction nor the hedged item, as modified by the covered 
modification, needs to be reidentified under Sec.  1.1221-2(f).
    The same commenter noted that Sec.  1.1001-6(c) of the Proposed 
Regulations does not include modifications to add or amend fallback 
provisions and recommended that the Final Regulations clarify whether 
the rules in that section apply to such modifications. The commenter 
further stated that, if a debt instrument and a hedge that reference 
the same ceasing IBOR are integrated under Sec.  1.1275-6 and the 
parties' covered modifications of the two instruments result in the 
fallback provisions being slightly mismatched either in timing (that 
is, the fallbacks have slightly different triggers) or amount (that is, 
the fallback rates are slightly different), that mismatch of the 
fallback provisions could cause a leg out of the integrated transaction 
even before either fallback provision is triggered. The commenter 
recommended that such mismatched fallback provisions not cause a leg 
out of an integrated transaction under Sec.  1.1275-6, Sec.  1.988-
5(a), or Sec.  1.148-4(h). In response to these comments, Sec.  1.1001-
6(c) of the Final Regulations applies to a covered modification, which 
is generally defined to include the addition or amendment of fallback 
provisions. Also, Sec.  1.1001-6(c)(2) of the Final Regulations 
generally provides that a covered modification that adds or amends 
fallback provisions is treated as not legging out of a transaction 
integrated under Sec.  1.1275-6, Sec.  1.988-5(a), or Sec.  1.148-4(h). 
The Treasury Department and the IRS caution, however, that any mismatch 
in the fallback provisions of the components of a transaction 
integrated under Sec.  1.1275-6, Sec.  1.988-5(a), or Sec.  1.148-4(h) 
may result in legging out when one or more of those fallback provisions 
are triggered. In that case, a taxpayer would first determine whether 
the rules in Sec.  1.1001-6(c)(1) of the Final Regulations apply to any 
modification that results from the triggered fallback provisions.
    Several commenters raised questions about the Proposed Regulations' 
requirement that, to avoid legging out under Sec.  1.1275-6, Sec.  
1.988-5(a), or Sec.  1.148-4(h), the integrated hedge must continue to 
qualify as a Sec.  1.1275-6 hedge, a Sec.  1.988-5(a) hedge, or a 
qualified hedge, respectively, after the modification. Two commenters 
asserted that certain minor mismatches between the modified terms of 
the components will inevitably arise (either because of minor 
differences in the modified terms or because the components are not 
modified at the same time) and that such mismatches may prevent the 
modified contracts from qualifying for continued integration under 
Sec.  1.1001-6(c) of the Proposed Regulations. These commenters 
recommended that, if under the Final Regulations a modification is not 
treated as an exchange of property for purposes of section 1001, that 
modification also not be treated as legging out of an integrated 
transaction under Sec.  1.1275-6 or Sec.  1.988-5(a), regardless of 
whether the modified contracts would otherwise continue to qualify for 
integration. Alternatively, these commenters recommended that the Final 
Regulations provide a grace period during which the modified components 
of the integrated transaction do not have to meet the qualifications 
for integration. The Final Regulations adopt these commenters' 
alternative recommendation. Sections 1.1001-6(c)(1)(i), (ii), and (iv) 
of the

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Final Regulations provide a grace period during which a covered 
modification of a component of a transaction integrated under Sec.  
1.1275-6, Sec.  1.988-5(a), or Sec.  1.148-4(h) does not result in 
legging out of that integrated transaction, notwithstanding any 
mismatch in timing or amount of payments that results from the covered 
modification during the grace period. The grace period lasts 90 days 
and starts on the date of the first covered modification of any 
component of the integrated transaction. If, however, the hedge 
component of the integrated transaction does not qualify as a Sec.  
1.1275-6 hedge, a Sec.  1.988-5(a) hedge, or a qualified hedge under 
Sec.  1.148-4(h), as appropriate, by the end of the grace period, the 
covered modification is a legging out as of the date of the covered 
modification.
    These commenters also observed that taxpayers may enter into 
temporary hedges, such as basis swaps, to manage the economic risk 
posed by temporary mismatches between the terms of the components of a 
transaction integrated under Sec.  1.1275-6 or Sec.  1.988-5(a). The 
commenters recommended that the Final Regulations accommodate the 
temporary integration of these hedges. The Final Regulations adopt this 
comment and provide that temporary hedges entered into to mitigate the 
economic effect of such temporary mismatches may be integrated during 
the 90-day grace period without disruption to a transaction integrated 
under Sec.  1.1275-6 or Sec.  1.988-5(a).
    One commenter offered several comments that are specific to the 
rules in the Proposed Regulations on integration of tax-advantaged 
bonds under Sec.  1.148-4(h). This commenter recommended that the Final 
Regulations clarify that the rules in Sec.  1.1001-6(c) for integration 
of tax-advantaged bonds apply to a qualified hedge that is super-
integrated under Sec.  1.148-4(h)(4). Section 1.148-4(h)(4) generally 
permits only negligible mismatches in timing and amount of payments on 
super-integrated hedges and bonds, and super-integration of taxable-
index hedges, such as hedges based on IBORs, is even more strictly 
limited. Accordingly, the Treasury Department and the IRS do not adopt 
this comment, and the Final Regulations clarify that Sec.  1.1001-
6(c)(1)(iv) does not apply to hedges and bonds integrated under Sec.  
1.148-4(h)(4).
    This commenter also requested that the Final Regulations provide 
that a one-time payment does not cause a hedge to fail to meet the 
requirements for qualification under Sec.  1.148-4(h)(3)(iv)(C), as 
required by Sec.  1.1001-6(c) of the Proposed Regulations. The 
nonperiodic nature of a one-time payment could prevent qualification 
under several of the requirements identified in Sec.  1.148-
4(h)(3)(iv)(C), such as the requirement that the contract contain no 
significant investment element and the requirement that the payments on 
the hedge correspond closely in time to the payments on the hedged 
bonds. The Treasury Department and the IRS have determined that, in 
each case, the obstacle to qualification can be eliminated by treating 
the qualified one-time payment as a series of periodic payments spread 
over time. Accordingly, Sec.  1.1001-6(c)(1)(iv) of the Final 
Regulations provides that, solely for purposes of applying the 
qualification requirements identified in Sec.  1.148-4(h)(3)(iv)(C), a 
qualified one-time payment on the hedge or the hedged bonds is 
allocated in a manner consistent with the way in which a termination 
payment on a variable yield issue is allocated under Sec.  1.148-
4(h)(3)(iv)(H) and the qualification requirements under Sec.  1.148-
4(h)(3)(iv)(C) are applied as if the qualified one-time payment were a 
series of periodic payments.

3. Fast-Pay Stock

    Section 1.7701(l)-3 provides rules that prevent the avoidance of 
tax by persons participating in fast-pay arrangements. A fast-pay 
arrangement is defined in Sec.  1.7701(l)-3(b)(1) as any arrangement in 
which a corporation has fast-pay stock outstanding for any part of its 
taxable year. Fast-pay stock is defined in Sec.  1.7701(l)-3(b)(2)(i) 
as stock structured so that dividends (as defined in section 316) paid 
by the corporation with respect to the stock are economically (in whole 
or in part) a return of the holder's investment (as opposed to only a 
return on the holder's investment). Section 1.7701(l)-3(b)(2)(ii) 
provides that the determination of whether stock is fast-pay stock is 
based on all facts and circumstances. Stock is examined when it is 
issued to determine if it is fast-pay stock and, ``for stock that is 
not fast-pay stock when issued, when there is a significant 
modification in the terms of the stock or the related agreements or a 
significant change in the relevant facts and circumstances.'' Id.
    One commenter stated that, in certain circumstances, a covered 
modification of preferred stock could cause the stock to satisfy the 
definition of fast-pay stock despite the fact that the parties modified 
the stock not for the purpose of avoiding tax, but rather for the 
purpose of addressing the discontinuation of an IBOR. Because stock is 
re-examined to determine if it is fast-pay stock upon the occurrence of 
either ``a significant modification in the terms of the stock or the 
related agreements'' or ``a significant change in the relevant facts 
and circumstances,'' the commenter recommended that the Final 
Regulations provide that a covered modification is neither a 
significant modification nor a significant change for this purpose.
    The Treasury Department and the IRS have determined that such a 
rule would further the purpose of the Final Regulations to facilitate 
the transition away from IBORs that will be discontinued. In addition, 
the scope and operation of the recommended rule are generally 
consistent with the scope and operation of the rules in Sec. Sec.  
1.1001-6(b)(1) and (d) of the Final Regulations (treatment of covered 
modifications under section 1001 and under chapter 4, respectively). 
Accordingly, the Final Regulations adopt this comment and provide in 
Sec.  1.1001-6(e) that a covered modification of stock is not a 
significant modification in the terms of the stock or the related 
agreements or a significant change in the relevant facts and 
circumstances for purposes of Sec.  1.7701(l)-3(b)(2)(ii). Unlike 
Sec. Sec.  1.1001-6(b)(1) and (d) of the Final Regulations, however, 
Sec.  1.1001-6(e) of the Final Regulations further provides that, if a 
covered modification and a noncovered modification are made at the same 
time or as part of the same plan and the noncovered modification is a 
significant modification in the terms of the stock or the related 
agreements or a significant change in the relevant facts and 
circumstances, then Sec.  1.7701(l)-3(b)(2)(ii) applies and all of the 
facts and circumstances, including the covered modification and the 
noncovered modification, are considered in determining whether the 
stock is fast-pay stock.

4. Investment Trusts Under Sec.  301.7701-4(c)(1)

    Under Sec.  301.7701-4(c)(1), an investment trust is not classified 
as a trust if there is a power under the trust agreement to vary the 
investment of the certificate holders. One commenter recommended that a 
covered modification of the income-apportioning terms of an ownership 
interest be treated as not manifesting a power to vary the investment 
of certificate holders in a trust under Sec.  301.7701-4(c)(1). The 
Final Regulations adopt this comment, providing in Sec.  1.1001-6(f) 
that neither a covered modification of a contract held by an investment 
trust nor a covered modification of an ownership interest in the 
investment trust manifest a power to

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vary the investment of the certificate holder for this purpose.

5. Rules Regarding Qualified One-Time Payments

    The Proposed Regulations generally provide in Sec.  1.1001-6(d) 
that the character and source of a one-time payment made by a given 
payor is the same as the source and character of a payment under the 
contract by that payor. For example, a one-time payment by a lessee on 
a lease is characterized as a payment of rent and sourced accordingly. 
The Treasury Department and the IRS received several comments 
requesting clarification on how this rule applies to certain financial 
contracts. Several commenters also requested clarification on the 
timing of tax items associated with a one-time payment. One commenter 
requested guidance on how a one-time payment is treated for purposes of 
the arbitrage investment restrictions and private use restrictions that 
apply to tax-advantaged bonds. The Treasury Department and the IRS are 
still considering how best to address these issues relating to 
qualified one-time payments. Until the Treasury Department and the IRS 
publish further guidance, taxpayers may continue to rely on the rule in 
Sec.  1.1001-6(d) of the Proposed Regulations to determine source and 
character of a qualified one-time payment under the Final Regulations.

6. REMICs

    Section 1.860G-1(e) of the Proposed Regulations provides special 
rules applicable to REMICs that have issued interests with an IBOR-
based rate or that hold obligations with an IBOR-based rate. Section 
1.860G-1(e)(4) of the Proposed Regulations provides certain rules 
addressing the treatment of reasonable costs incurred to effect a 
modification that qualifies for special treatment under Sec.  1.1001-
6(a)(1), (2), or (3) of the Proposed Regulations. One commenter noted 
that the governing documents for a REMIC may require tax opinions and 
rating agency confirmations in connection with the modifications 
contemplated in the Proposed Regulations and recommended that the 
Treasury Department and the IRS confirm that the costs of obtaining 
these materials are ``reasonable costs'' within the meaning of Sec.  
1.860G-1(e)(4) of the Proposed Regulations. Whether a cost is 
reasonable depends upon the facts and circumstances relating both to 
the nature of the cost and the amount of the cost. However, the 
Treasury Department and the IRS generally agree that the costs of 
obtaining tax opinions and rating agency confirmations required by the 
governing documents for a REMIC are reasonable in nature.

7. Interest Expense of a Foreign Corporation

    The Proposed Regulations provide in Sec.  1.882-5(d)(5)(ii)(B) that 
a foreign corporation that is a bank may elect to compute interest 
expense attributable to excess U.S.-connected liabilities using a 
yearly average of SOFR. One commenter stated that a yearly average of 
SOFR is not an equitable substitute for 30-day USD LIBOR, the rate that 
foreign banks are permitted to elect for this purpose under the 
existing regulations, because 30-day USD LIBOR is typically a higher 
rate than a yearly average of SOFR. This commenter recommended that, in 
lieu of SOFR, the Final Regulations either refer to a widely accepted 
interest rate benchmark that is more similar than SOFR to 30-day USD 
LIBOR or add a fixed adjustment spread to the yearly average of SOFR.
    The Treasury Department and the IRS continue to study the 
appropriate rate to replace 30-day USD LIBOR for purposes of the 
published rate election under Sec.  1.882-5(d)(5)(ii)(B). In evaluating 
the appropriate replacement rate, the Treasury Department and the IRS 
will continue to balance the administrative convenience of providing 
taxpayers an election to use the annual published rate with the need 
for a replacement rate that more accurately reflects the taxpayer's 
borrowing costs. In providing taxpayers with an election to use a 
published rate, the Treasury Department and the IRS must ensure that 
the replacement rate does not overstate the amount of interest expense 
allocable to income that is effectively connected with the conduct of a 
U.S. trade or business. Until final regulations are published that 
replace the 30-day USD LIBOR election provided in Sec.  1.882-
5(d)(5)(ii)(B), taxpayers may continue to apply either the general rule 
or the annual published rate election provided under Sec.  1.882-
5(d)(5)(ii) to calculate interest on excess U.S.-connected liabilities. 
Taxpayers may also continue to rely on the rule in Sec.  1.882-
5(d)(5)(ii)(B) of the Proposed Regulations and compute interest on 
excess U.S.-connected liabilities by computing a yearly average SOFR 
based on the rates published by the Federal Bank of New York for the 
taxable year. Although commenters provided some ideas on a rate that 
could be closer to a replacement for 30-day LIBOR (for example, a 
widely accepted interest rate benchmark or adding a fixed adjustment 
spread to the yearly average of SOFR), the Treasury Department and the 
IRS continue to request recommendations for a specific rate that would 
be an appropriate replacement to 30-day LIBOR for computing interest 
expense on excess U.S.-connected liabilities for purposes of Sec.  
1.882-5(d)(5)(ii)(B). The Treasury Department and the IRS anticipate 
issuing additional guidance addressing Sec.  1.882-5(d)(5)(ii)(B) 
before 30-day USD LIBOR is discontinued in 2023.

8. Change of Accounting Method

    One commenter asked the Treasury Department and the IRS to address 
whether changing from an IBOR-based discount rate to a discount rate 
based on a different interest rate benchmark for the purpose of valuing 
securities under the mark-to-market rules in section 475 is a change in 
method of accounting that requires the consent of the Secretary under 
section 446(e). The commenter noted that this change may occur either 
at the time when the relevant IBOR is discontinued or in advance of 
that time in anticipation of the IBOR's discontinuation. To facilitate 
an orderly transition in connection with the discontinuation of IBORs 
and to treat changes from an IBOR-based discount rate in a consistent 
manner, the Treasury Department and the IRS will not treat a change 
from a discount rate that is based on a discontinued IBOR (as defined 
in Sec.  1.1001-6(h)(4) of the Final Regulations) to a discount rate 
that is a qualified rate for the purpose of valuing securities under 
the mark-to-market rules in section 475 as a change in method of 
accounting under section 446(e).

9. Applicability Dates

    The Proposed Regulations under Sec. Sec.  1.860G-1(e), 1.1001-6, 
and 1.1275-2(m) generally propose that the Final Regulations permit 
taxpayers to apply the Final Regulations retroactively, as authorized 
under section 7805(b)(7). However, the Proposed Regulations under Sec.  
1.1001-6 propose that the Final Regulations require as a condition of a 
taxpayer's retroactive application that all the taxpayer's related 
parties also apply Sec.  1.1001-6 retroactively. One commenter 
requested that this requirement be more clearly stated, and the Final 
Regulations do so in Sec.  1.1001-6(k).
    Another commenter observed that sections 267(b) and 707(b)(1), 
under which relatedness is determined for purposes of the applicability 
dates in the Proposed Regulations, do not effectively address 
governmental entities or tax-exempt entities described in section 
501(c)(3). This commenter recommended that relatedness be

[[Page 174]]

determined for such entities under Sec.  1.150-1(b) and (e). The 
Treasury Department and the IRS agree with this comment and adopt the 
commenter's recommendation in Sec. Sec.  1.1001-6(k) and 1.1275-2(m)(5) 
of the Final Regulations.

Effect on Other Documents

    Rev. Proc. 2020-44, 2020-45 I.R.B. 991, is amplified.

Special Analyses

I. Regulatory Planning and Review--Economic Analysis

    Executive Orders 12866 and 13563 direct agencies to assess costs 
and benefits of available regulatory alternatives and, if regulation is 
necessary, to select regulatory approaches that maximize net benefits 
(including (i) potential economic, environmental, and public health and 
safety effects, (ii) potential distributive impacts, and (iii) equity). 
Executive Order 13563 emphasizes the importance of quantifying both 
costs and benefits, reducing costs, harmonizing rules, and promoting 
flexibility.
    These final regulations have been designated as subject to review 
under Executive Order 12866 pursuant to the Memorandum of Agreement 
(April 11, 2018) (MOA) between the Treasury Department and the Office 
of Management and Budget (OMB) regarding review of tax regulations. The 
Office of Information and Regulatory Affairs has designated these final 
regulations as economically significant under section 1(c) of the MOA.
A. Background, Need for the Final Regulations, and Economic Analysis of 
Final Regulations
    A very large volume of U.S. financial products and contracts 
include terms or conditions that reference LIBOR or, more generally, 
IBORs. Concern about manipulation and a decline in the volume of the 
funding from which LIBOR is calculated led to recommendations for the 
development of alternatives to LIBOR that would be based on 
transactions in a more robust underlying market. In addition, on July 
27, 2017, the U.K. Financial Conduct Authority, the U.K. regulator 
tasked with overseeing LIBOR, announced that all currency and term 
variants of LIBOR, including USD LIBOR, may be phased out after 2021 
and not be published after that timeframe. The administrator of LIBOR, 
the ICE Benchmark Administration, announced on March 5, 2021, that 
publication of overnight, one-month, three-month, six-month, and 12-
month USD LIBOR will cease immediately following the LIBOR publication 
on June 30, 2023, and that publication of all other currency and tenor 
variants of LIBOR will cease immediately following the LIBOR 
publication on December 31, 2021.
    The ARRC, a group of stakeholders affected by the cessation of the 
publication of USD LIBOR, was convened to identify an alternative rate 
and to facilitate voluntary adoption of that alternative rate. The ARRC 
recommended SOFR as a potential replacement for USD LIBOR. Essentially 
all financial products and contracts that currently contain conditions 
or legal provisions that rely on LIBOR and other IBORs are expected to 
transition to SOFR or similar alternatives in the next few years. This 
transition will involve changes in debt, derivatives, and other 
financial contracts to adopt SOFR or other alternative reference rates. 
The ARRC has estimated that the total exposure to USD LIBOR was close 
to $200 trillion in 2016, of which approximately 95 percent were in 
over-the-counter derivatives. ARRC further notes that USD LIBOR is also 
referenced in several trillion dollars of corporate loans, floating-
rate mortgages, and similar financial products. In the absence of 
further tax guidance, the vast majority of expected changes in such 
contracts could lead to the recognition of gains (or losses) in these 
contracts for U.S. income tax purposes and to correspondingly 
potentially large tax liabilities for their holders. To address this 
issue, the final regulations provide that changes in debt instruments, 
derivative contracts, and other affected contracts to replace reference 
rates based on discontinued IBORs in a covered modification (both as 
defined in the final regulations) will not result in tax realization 
events under section 1001 and relevant regulations thereunder. For this 
purpose, a covered modification is generally the replacement of a 
discontinued IBOR with a qualified rate, provided that the replacement 
is not excluded under Sec.  1.1001-6(j)(1) through (5) of these final 
regulations (the excluded modifications). The excluded modifications 
ensure that a covered modification includes only modifications to the 
cash flows of an IBOR-referencing contract intended to address the 
replacement of the IBOR-based rate in the contract and that 
modifications of contracts in a manner that is intended to change the 
amount or timing of contractual cash flows for other reasons or 
purposes remain subject to the general rules in section 1001 and the 
regulations thereunder. The final regulations also provide 
corresponding guidance on hedging transactions and derivatives to the 
effect that taxpayers may modify the components of hedged or integrated 
transactions to replace discontinued IBORs in a covered modification 
without affecting the tax treatment of the hedges or underlying 
transactions.
    In the absence of these final regulations, parties to contracts 
affected by the cessation of the publication of LIBOR would either 
suffer tax consequences to the extent that a change to the contract 
results in a tax realization event under section 1001 or attempt to 
find alternative contracts that avoid such a tax realization event, 
which may be difficult as a commercial matter. Both such options would 
be both costly and highly disruptive to U.S. financial markets. A large 
number of contracts may end up being breached, which may lead to 
bankruptcies or other legal proceedings. The types of actions that 
contract holders might take in the absence of these final regulations 
are difficult to predict because such an event is outside recent 
experience in U.S. financial markets. This financial disruption would 
be particularly unproductive because the economic characteristics of 
the financial products and contracts under the new rates would be 
essentially unchanged. Thus, there is no underlying economic rationale 
for a tax realization event.
    The Treasury Department and the IRS project that these final 
regulations would avoid this costly and unproductive disruption. The 
Treasury Department and the IRS further project that these final 
regulations, by implementing the regulatory provisions requested by 
ARRC and taxpayers, will help facilitate the economy's adaptation to 
the cessation of LIBOR in a least-cost manner.

II. Regulatory Flexibility Act

    It is hereby certified that the Final Regulations will not have a 
significant economic impact on a substantial number of small entities 
within the meaning of section 601(6) of the Regulatory Flexibility Act 
(5 U.S.C. chapter 6).
    As discussed elsewhere in this preamble, the administrator of all 
currency and tenor variants of LIBOR has announced that publication of 
overnight, one-month, three-month, six-month, and 12-month USD LIBOR 
will cease on June 30, 2023, and that publication of all other currency 
and tenor variants of LIBOR will cease on December 31, 2021. Many 
contracts, including financial contracts such as debt instruments and 
derivative contracts, refer to LIBOR or another IBOR to determine the 
parties' rights

[[Page 175]]

and obligations under the contract. When parties to IBOR-referencing 
contracts modify those contracts in anticipation of the discontinuation 
of the referenced IBOR, that modification can be a tax realization 
event, giving rise to gain, loss, income, or deduction. That 
modification can also cause other unintended tax consequences.
    The number of small entities potentially affected by the Final 
Regulations is unknown but could be substantial because entities of all 
sizes are parties to contracts that reference a discontinued IBOR. 
Although a substantial number of small entities is potentially affected 
by the Final Regulations, the Treasury Department and the IRS have 
concluded that the Final Regulations will not have a significant 
economic impact on a substantial number of small entities. This is 
because the purpose and effect of the Final Regulations is to minimize 
the economic impact of the transition away from LIBOR and other 
discontinued IBORs by preventing many of the tax consequences that 
might otherwise flow when taxpayers modify IBOR-referencing contracts 
in anticipation of the cessation of a discontinued IBOR. Furthermore, 
the Final Regulations do not impose a collection of information on any 
taxpayers, including small entities. Accordingly, the Final Regulations 
will not have a significant economic impact on a substantial number of 
small entities.

III. Unfunded Mandates Reform Act

    Section 202 of the Unfunded Mandates Reform Act of 1995 requires 
that agencies assess anticipated costs and benefits and take certain 
other actions before issuing a final rule that includes any Federal 
mandate that may result in expenditures in any one year by a state, 
local, or tribal government, in the aggregate, or by the private 
sector, of $100 million in 1995 dollars, updated annually for 
inflation. The Final Regulations do not include any Federal mandate 
that may result in expenditures by state, local, or tribal governments, 
or by the private sector in excess of that threshold.

IV. Executive Order 13132: Federalism

    Executive Order 13132 (entitled ``Federalism'') prohibits an agency 
from publishing any rule that has federalism implications if the rule 
either imposes substantial, direct compliance costs on state and local 
governments, and is not required by statute, or preempts state law, 
unless the agency meets the consultation and funding requirements of 
section 6 of the Executive Order. The Final Regulations do not have 
federalism implications and do not impose substantial direct compliance 
costs on state and local governments or preempt state law within the 
meaning of the Executive Order.

V. Congressional Review Act

    The Administrator of the Office of Information and Regulatory 
Affairs of the OMB has determined that this Treasury decision is a 
major rule for purposes of the Congressional Review Act (5 U.S.C. 801 
et seq.) (``CRA''). Under section 801(3) of the CRA, a major rule takes 
effect 60 days after the rule is published in the Federal Register. 
Accordingly, the Treasury Department and IRS are adopting the Final 
Regulations with the delayed effective date generally prescribed under 
the Congressional Review Act.

Drafting Information

    The principal authors of these final regulations are Caitlin Holzem 
and Spence Hanemann of the Office of Associate Chief Counsel (Financial 
Institutions and Products). However, other personnel from the Treasury 
Department and the IRS participated in their development.

Availability of IRS Documents

    The revenue procedure cited in this preamble is published in the 
Internal Revenue Bulletin (or Cumulative Bulletin) and is available 
from the Superintendent of Documents, U.S. Government Publishing 
Office, Washington, DC 20402, or by visiting the IRS website at https://www.irs.gov.

List of Subjects

26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

26 CFR Part 301

    Employment taxes, Estate taxes, Excise taxes, Gift taxes, Income 
taxes, Penalties, Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

    Accordingly, 26 CFR parts 1 and 301 are amended as follows:

PART 1--INCOME TAXES

0
Paragraph 1. The authority citation for part 1 is amended by revising 
the entry for Sec.  1.860G-1 and adding an entry in numerical order for 
Sec.  1.1001-6 to read in part as follows:

    Authority:  26 U.S.C. 7805 * * *
    Section 1.860G-1 also issued under 26 U.S.C. 860G(a)(1)(B), 
(d)(2)(E), and (e).
* * * * *
    Section 1.1001-6 also issued under 26 U.S.C. 148(i), 26 U.S.C. 
988(d), 26 U.S.C. 1275(d), and 26 U.S.C. 7701(l).
* * * * *


0
Par. 2. Section 1.860A-0 is amended by adding entries for Sec.  1.860A-
1(b)(6) and (7) and Sec.  1.860G-1(e) to read as follows:


Sec.  1.860A-0  Outline of REMIC provisions.

* * * * *


Sec.  1.860A1-1  Effective dates and transition rules.

* * * * *
    (b) * * *
    (6) Exceptions for certain modified obligations.
    (7) Exceptions for certain modifications of obligations that refer 
to certain interbank offered rates.
* * * * *


Sec.  1.860G1 1  Definition of regular and residual interests.

* * * * *
    (e) Transition from certain interbank offered rates.
    (1) In general.
    (2) Change in reference rate for a regular interest after the 
startup day.
    (3) Contingencies of rate on a regular interest.
    (4) Reasonable expenses incurred to make covered modifications.
* * * * *


0
Par. 3. Section 1.860A-1 is amended by adding paragraph (b)(7) to read 
as follows:


Sec.  1.860A1 -1  Effective dates and transition rules.

* * * * *
    (b) * * *
    (7) Exceptions for certain modifications of obligations that refer 
to certain interbank offered rates--(i) Paragraphs (e)(2) and (4) of 
Sec.  1.860G-1 apply with respect to a covered modification that occurs 
on or after March 7, 2022. However, paragraphs (e)(2) and (4) of Sec.  
1.860G-1 may be applied with respect to a covered modification that 
occurs before March 7, 2022. See section 7805(b)(7).
    (ii) Paragraph (e)(3) of Sec.  1.860G-1 applies to a regular 
interest in a REMIC issued on or after March 7, 2022. However, 
paragraph (e)(3) of Sec.  1.860G-1 may be applied to a regular interest 
in a REMIC issued before March 7, 2022. See section 7805(b)(7).

0
Par. 4. Section 1.860G-1 is amended by:

[[Page 176]]

0
1. Removing ``paragraph (b)(3)'' in paragraph (a)(5) and adding in its 
place ``paragraphs (b)(3) and (e)(4)''.
0
2. Adding paragraph (e).
    The addition reads as follows:


Sec.  1.860G1-1  Definition of regular and residual interests.

* * * * *
    (e) Transition from certain interbank offered rates--(1) In 
general. This paragraph (e) provides rules relating to the modification 
of the terms of a regular interest in a REMIC or the terms of an asset 
held by a REMIC as part of the transition away from the London 
Interbank Offered Rate and certain other interbank offered rates. For 
purposes of this paragraph (e), covered modification and discontinued 
IBOR have the meanings provided in Sec.  1.1001-6(h)(1) and (4), 
respectively. See Sec.  1.1001-6 for additional rules that may apply to 
an interest in a REMIC that provides for a rate referencing a 
discontinued IBOR.
    (2) Change in reference rate for a regular interest after the 
startup day. A covered modification of a regular interest in a REMIC 
that occurs after the startup day is disregarded in determining whether 
the modified regular interest has fixed terms on the startup day under 
paragraph (a)(4) of this section.
    (3) Contingencies of rate on a regular interest. An interest in a 
REMIC does not fail to qualify as a regular interest solely because it 
is subject to a contingency whereby a rate that references a 
discontinued IBOR and is a variable rate permitted under paragraph 
(a)(3) of this section may change to a fixed rate or a different 
variable rate permitted under paragraph (a)(3) of this section in 
anticipation of the discontinued IBOR becoming unavailable or 
unreliable.
    (4) Reasonable expenses incurred to make covered modifications. An 
interest in a REMIC does not fail to qualify as a regular interest 
solely because it is subject to a contingency whereby the amount of 
payments of principal or interest (or other similar amounts) with 
respect to the interest in the REMIC is reduced by reasonable costs 
incurred to effect a covered modification. In addition, payment by a 
party other than the REMIC of reasonable costs incurred to effect a 
covered modification is not a contribution to the REMIC for purposes of 
section 860G(d).

0
Par. 5. Section 1.1001-6 is added to read as follows:


Sec.  1.10011-6  Transition from certain interbank offered rates.

    (a) In general. This section provides rules relating to the 
modification of the terms of a contract as part of the transition away 
from the London Interbank Offered Rate and certain other interbank 
offered rates. In general, paragraphs (b) through (g) of this section 
provide the operative rules for a covered modification. Paragraph (h) 
of this section defines certain terms that are used in these operative 
rules, such as covered modification, qualified rate, discontinued IBOR, 
associated modification, and qualified one-time payment. Paragraph (j) 
of this section describes certain modifications that are not covered 
modifications and provides examples that illustrate the operation of 
the rules in paragraph (j) of this section. For rules regarding 
original issue discount on certain debt instruments that provide for a 
rate referencing a discontinued IBOR, see Sec.  1.1275-2(m). For rules 
regarding certain interests in a REMIC that provide for a rate 
referencing a discontinued IBOR, see Sec.  1.860G-1(e).
    (b) Treatment under section 1001--(1) Covered modifications. A 
covered modification of a contract is not treated as the exchange of 
property for other property differing materially in kind or in extent 
for purposes of Sec.  1.1001-1(a). For example, if the terms of a debt 
instrument that pays interest at a rate referencing the U.S.-dollar 
London Interbank Offered Rate (USD LIBOR) are modified to provide that 
the debt instrument pays interest at a qualified rate referencing the 
Secured Overnight Financing Rate published by the Federal Reserve Bank 
of New York (SOFR) and the modification is not described in paragraph 
(j) of this section, the modification is not treated as the exchange of 
property for other property differing materially in kind or in extent 
for purposes of Sec.  1.1001-1(a).
    (2) Contemporaneous noncovered modifications. If a covered 
modification is made at the same time as a noncovered modification, 
Sec.  1.1001-1(a) or Sec.  1.1001-3, as appropriate, applies to 
determine whether the noncovered modification results in the exchange 
of property for other property differing materially in kind or in 
extent. In applying Sec.  1.1001-1(a) or Sec.  1.1001-3 for this 
purpose, the covered modification is treated as part of the terms of 
the contract prior to the noncovered modification. For example, if the 
parties to a debt instrument modify the interest rate in a manner that 
is a covered modification and contemporaneously extend the final 
maturity date of the debt instrument, which is a noncovered 
modification, only the extension of the final maturity date is analyzed 
under Sec.  1.1001-3 and, for purposes of that analysis, the modified 
interest rate is treated as a term of the instrument prior to the 
extension of the final maturity date.
    (c) Effect of a covered modification on integrated transactions and 
hedging transactions--(1) In general. Except as otherwise provided in 
paragraph (c)(2) of this section, the rules in paragraphs (c)(1)(i) 
through (iv) of this section determine the effect of a covered 
modification on an integrated transaction under Sec.  1.1275-6, a 
qualified hedging transaction under Sec.  1.988-5(a), a hedging 
transaction under Sec.  1.446-4, or a qualified hedging transaction 
under Sec.  1.148-4(h).
    (i) A covered modification of one or more contracts that are part 
of an integrated transaction under Sec.  1.1275-6 is treated as not 
legging out of the integrated transaction, provided that, no later than 
the end of the 90-day period beginning on the date of the first covered 
modification of any such contract, the financial instrument that 
results from any such covered modifications satisfies the requirements 
to be a Sec.  1.1275-6 hedge (as defined in Sec.  1.1275-6(b)(2)) with 
respect to the qualifying debt instrument that results from any such 
covered modification. If a taxpayer enters into a financial instrument 
intended to mitigate the economic effect of a temporary mismatch of the 
legs of the integrated transaction during that 90-day period (a Sec.  
1.1275-6 interim hedge), the integration of the Sec.  1.1275-6 interim 
hedge with the other components of the integrated transaction during 
the 90-day period is treated as not legging into a new integrated 
transaction and the termination of the Sec.  1.1275-6 interim hedge 
before the end of the 90-day period is treated as not legging out of 
the existing integrated transaction.
    (ii) A covered modification of one or more contracts that are part 
of a qualified hedging transaction under Sec.  1.988-5(a) is treated as 
not legging out of the qualified hedging transaction, provided that, no 
later than the end of the 90-day period beginning on the date of the 
first covered modification of any such contract, the financial 
instrument or series or combination of financial instruments that 
results from any such covered modifications satisfies the requirements 
to be a Sec.  1.988-5(a) hedge (as defined in Sec.  1.988-5(a)(4)) with 
respect to the qualifying debt instrument that results from any such 
covered modification. If a taxpayer enters into a financial instrument 
intended to mitigate the economic effect of a temporary mismatch of the 
legs of the qualified hedging transaction during that 90-day period (a 
Sec.  1.988-5(a) interim hedge), the integration of the

[[Page 177]]

Sec.  1.988-5(a) interim hedge with the other components of the 
qualified hedging transaction during the 90-day period is treated as 
not legging into a new qualified hedging transaction and the 
termination of the Sec.  1.988-5(a) interim hedge before the end of the 
90-day period is treated as not legging out of the existing qualified 
hedging transaction.
    (iii) A covered modification of one leg of a transaction subject to 
the hedge accounting rules in Sec.  1.446-4 is not treated as a 
disposition or termination (within the meaning of Sec.  1.446-4(e)(6)) 
of either leg of the transaction.
    (iv) A covered modification of a qualified hedge or of the tax-
advantaged bonds with which the qualified hedge is integrated under 
Sec.  1.148-4(h)(1) is treated as not terminating the qualified hedge 
under Sec.  1.148-4(h)(3)(iv)(B), provided that, no later than the end 
of the 90-day period beginning on the date of the first covered 
modification of either the qualified hedge or the hedged bonds, the 
qualified hedge that results from any such covered modification 
satisfies the requirements to be a qualified hedge (determined by 
applying the special rules for certain modifications of qualified 
hedges under Sec.  1.148-4(h)(3)(iv)(C)) with respect to the hedged 
bonds that result from any such covered modification. Solely for 
purposes of determining whether the qualified hedge that results from a 
covered modification satisfies the requirements to be a qualified hedge 
with respect to the hedged bonds that result from any such covered 
modification in the preceding sentence, a qualified one-time payment 
with respect to the hedge or the hedged bonds (or both) is allocated in 
a manner consistent with the allocation of a termination payment for a 
variable yield issue under Sec.  1.148-4(h)(3)(iv)(H) and treated as a 
series of periodic payments. This paragraph (c)(1)(iv) does not apply 
if, prior to any covered modifications, the qualified hedge and the 
tax-advantaged bond are integrated under Sec.  1.148-4(h)(4).
    (2) Fallback rates. If a covered modification of a contract that is 
part of an integrated transaction under Sec.  1.1275-6 is described in 
paragraph (h)(1)(ii) or (iii) of this section, that covered 
modification is treated as not legging out of the integrated 
transaction. If a covered modification of a contract that is part of a 
qualified hedging transaction under Sec.  1.988-5(a) is described in 
paragraph (h)(1)(ii) or (iii) of this section, that covered 
modification is treated as not legging out of the qualified hedging 
transaction. If a covered modification of a qualified hedge or of the 
tax-advantaged bonds with which the qualified hedge is integrated under 
Sec.  1.148-4(h) is described in paragraph (h)(1)(ii) or (iii) of this 
section, that covered modification is treated as not terminating the 
qualified hedge under Sec.  1.148-4(h)(3)(iv)(B).
    (d) Coordination with provision for existing obligations under 
chapter 4. A modification of a contract is not a material modification 
of that contract for purposes of Sec.  1.1471-2(b)(2)(iv) to the extent 
the modification is a covered modification. See paragraph (b)(2) of 
this section for rules that apply for purposes of Sec.  1.1471-
2(b)(2)(iv) when a modification to a contract includes both a covered 
modification and a contemporaneous noncovered modification.
    (e) Coordination with fast-pay stock rules. A covered modification 
of stock is not a significant modification in the terms of the stock or 
the related agreements or a significant change in the relevant facts 
and circumstances for purposes of Sec.  1.7701(l)-3(b)(2)(ii). If a 
covered modification is made at the same time as, or as part of a plan 
that includes, a noncovered modification and the noncovered 
modification is a significant modification in the terms of the stock or 
the related agreements or a significant change in the relevant facts 
and circumstances, then Sec.  1.7701(l)-3(b)(2)(ii) applies to 
determine whether the stock is fast-pay stock, taking into account all 
the facts and circumstances (including both the covered and noncovered 
modification).
    (f) Coordination with rules for investment trusts. A covered 
modification of a contract held by an investment trust does not 
manifest a power to vary the investment of the certificate holders for 
purposes of Sec.  301.7701-4(c)(1) of this chapter. Further, a covered 
modification of an ownership interest in an investment trust does not 
manifest a power to vary the investment of the certificate holder for 
purposes of Sec.  301.7701-4(c)(1) of this chapter.
    (g) [Reserved]
    (h) Definitions--(1) Covered modification. A covered modification 
is a modification or portion of a modification of the terms of a 
contract that is described in one or more of paragraphs (h)(1)(i) 
through (iii) of this section and that is not described in any of 
paragraphs (j)(1) through (5) of this section. Any modification of the 
terms of a contract described in section 4.02 of Rev. Proc. 2020-44, 
2020-45 I.R.B. 991, or described in other guidance published in the 
Internal Revenue Bulletin that supplements the list of modifications 
described in section 4.02 of Rev. Proc. 2020-44 or the definitions on 
which that section relies (see Sec.  601.601(d)(2)(ii)(a) of this 
chapter) is treated as a covered modification. For purposes of this 
section, a modification of the terms of a contract includes any 
modification of the terms of the contract, regardless of the form of 
the modification (for example, a modification may be an exchange of one 
contract for another, an amendment to the existing contract, or a 
modification accomplished indirectly through one or more transactions 
with third parties) and regardless of whether the modification is 
evidenced by an express agreement (oral or written), conduct of the 
parties, or otherwise. For purposes of this section, a contract 
includes but is not limited to a debt instrument, a derivative 
contract, stock, an insurance contract, and a lease agreement.
    (i) The terms of the contract are modified to replace an operative 
rate that references a discontinued IBOR with a qualified rate, to add 
an obligation for one party to make a qualified one-time payment (if 
any), and to make associated modifications (if any).
    (ii) The terms of the contract are modified to include a qualified 
rate as a fallback to an operative rate that references a discontinued 
IBOR and to make associated modifications (if any).
    (iii) The terms of the contract are modified to replace a fallback 
rate that references a discontinued IBOR with a qualified rate and to 
make associated modifications (if any).
    (2) Noncovered modification. A noncovered modification is any 
modification or portion of a modification of the terms of a contract 
that is not a covered modification.
    (3) Qualified rate--(i) In general. A qualified rate is any of the 
rates described in paragraph (h)(3)(ii) of this section, provided that 
the interest rate benchmark to which the rate refers and the 
discontinued IBOR identified in paragraph (h)(1)(i), (ii), or (iii) of 
this section are based on transactions conducted in the same currency 
or are otherwise reasonably expected to measure contemporaneous 
variations in the cost of newly borrowed funds in the same currency. 
For purposes of paragraphs (h)(1)(ii) and (iii) of this section, a 
single qualified rate may be comprised of one or more fallback rates 
(for example, a waterfall of fallback rates). Paragraph (h)(3)(iii) of 
this section provides additional rules for determining whether one or 
more fallback rates constitute a qualified rate, and paragraph 
(h)(3)(iv) of this section

[[Page 178]]

provides examples illustrating the operation of those rules.
    (ii) Rates. The following rates are described in this paragraph 
(h)(3)(ii):
    (A) A qualified floating rate, as defined in Sec.  1.1275-5(b), but 
without regard to the limitations on multiples set forth in Sec.  
1.1275-5(b) (examples of qualified floating rates generally include 
SOFR, the Sterling Overnight Index Average, the Tokyo Overnight Average 
Rate, the Swiss Average Rate Overnight, and the euro short-term rate 
administered by the European Central Bank);
    (B) An 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 a discontinued IBOR or its local 
currency equivalent in that jurisdiction;
    (C) A rate selected, endorsed, or recommended by the Alternative 
Reference Rates Committee as a replacement for USD LIBOR, provided that 
the Federal Reserve Bank of New York is an ex officio member of the 
Alternative Reference Rates Committee at the time of the selection, 
endorsement, or recommendation;
    (D) A rate that is determined by reference to a rate described in 
paragraph (h)(3)(ii)(A), (B), or (C) of this section, including a rate 
determined by adding or subtracting a specified number of basis points 
to or from the rate or by multiplying the rate by a specified number; 
and
    (E) A rate identified for purposes of this section as a qualified 
rate in guidance published in the Internal Revenue Bulletin (see Sec.  
601.601(d)(2)(ii)(a) of this chapter).
    (iii) Rules for fallback rates--(A) Multiple fallback rates. If the 
rate being tested as a qualified rate is comprised of more than one 
fallback rate, the rate is a qualified rate only if each individual 
fallback rate separately satisfies the requirements to be a qualified 
rate.
    (B) Indeterminable fallback rate. Except as provided in paragraph 
(h)(3)(iii)(C) of this section, if it is not possible to determine at 
the time of the modification being tested as a covered modification 
whether a fallback rate satisfies the requirements set forth in the 
first sentence of paragraph (h)(3)(i) of this section (for example, the 
calculation agent will determine the fallback rate at the time that the 
fallback rate is triggered based on factors that are not guaranteed to 
produce a rate described in paragraph (h)(3)(ii) of this section), the 
fallback rate is treated as not satisfying the requirements to be a 
qualified rate.
    (C) Fallback rate is a remote contingency. If the likelihood that 
any value will ever be determined under the contract by reference to a 
fallback rate is remote (determined at the time of the modification 
being tested as a covered modification), that fallback rate is treated 
as satisfying the requirements to be a qualified rate.
    (iv) Examples. The following examples illustrate the application of 
the rules in paragraphs (h)(3)(i) through (iii) of this section to 
qualified rates comprised of one or more fallback rates.
    (A) Example 1: Addition of a single fallback rate--(1) Facts. B is 
the issuer and L is the holder of a debt instrument that pays interest 
semiannually in U.S. dollars at a rate of six-month USD LIBOR and that 
contains no fallback provisions to address the pending discontinuation 
of six-month USD LIBOR. On July 1, 2022, B and L modify the debt 
instrument to add such fallback provisions (the new fallbacks). The new 
fallbacks provide that, upon the discontinuation of six-month USD 
LIBOR, six-month USD LIBOR will be replaced by a fallback rate equal to 
CME Group's forward-looking SOFR term rate of a six-month tenor (six-
month CME Term SOFR) plus a fixed spread that will be determined at the 
time of six-month USD LIBOR's discontinuation. Six-month USD LIBOR will 
be discontinued on June 30, 2023.
    (2) Analysis. The fallback rate is a qualified floating rate and 
is, therefore, described in paragraph (h)(3)(ii)(A) of this section. 
Moreover, because both six-month USD LIBOR and six-month CME Term SOFR 
are based on transactions conducted in U.S. dollars, the fallback rate 
satisfies the currency requirement in paragraph (h)(3)(i) of this 
section. As further provided in paragraph (h)(3)(i) of this section, B 
and L must also apply the rules in paragraph (h)(3)(iii)(A), (B), and 
(C) of this section to determine if the fallback rate is a qualified 
rate. Because the rate being tested as a qualified rate (i.e., the 
fallback rate) is comprised of only one fallback rate, paragraph 
(h)(3)(iii)(A) of this section has no effect. As discussed elsewhere in 
this paragraph (h)(3)(iv)(A)(2), it is evident at the time of the 
fallback rate's addition that the fallback rate satisfies the 
requirements set forth in the first sentence of paragraph (h)(3)(i) of 
this section, so paragraph (h)(3)(iii)(B) of this section has no 
effect. Because it appears likely at the time of the modification that 
the fallback rate will be used to determine interest on the debt 
instrument, paragraph (h)(3)(iii)(C) of this section has no effect. In 
summary, the fallback rate is described in paragraph (h)(3)(ii)(A) of 
this section and satisfies the currency requirement in paragraph 
(h)(3)(i) of this section, and none of the rules in paragraph 
(h)(3)(iii) of this section affect the analysis. Therefore, the 
fallback rate is a qualified rate.
    (B) Example 2: Addition of a single indeterminable fallback rate--
(1) Facts. The facts are the same as in paragraph (h)(3)(iv)(A)(1) of 
this section (Example 1), except that the new fallbacks provide that, 
upon the discontinuation of six-month USD LIBOR, B will select a 
replacement for six-month USD LIBOR based on the industry standard at 
the time of selection.
    (2) Analysis. As provided in paragraph (h)(3)(i) of this section, B 
and L must apply the rule in paragraph (h)(3)(iii)(B) of this section 
to determine whether the fallback rate is a qualified rate. Because it 
is not possible to determine at the time of the fallback rate's 
addition in 2022 whether the fallback rate (i.e., the replacement rate 
that B will select in 2023) satisfies the requirements set forth in the 
first sentence of paragraph (h)(3)(i) of this section, the fallback 
rate is treated as not satisfying the requirements to be a qualified 
rate under paragraph (h)(3)(iii)(B) of this section. Therefore, the 
fallback rate is not a qualified rate.
    (C) Example 3: Addition of a fallback waterfall that is a qualified 
rate--(1) Facts. The facts are the same as in paragraph 
(h)(3)(iv)(A)(1) of this section (Example 1), except that the new 
fallbacks provide for a fallback waterfall. The first tier of the 
fallback waterfall provides that, upon the discontinuation of six-month 
USD LIBOR, six-month USD LIBOR will be replaced by a fallback rate 
equal to six-month CME Term SOFR plus a fixed spread that will be 
determined at the time of six-month USD LIBOR's discontinuation. The 
second tier of the fallback waterfall provides that, upon the 
discontinuation of six-month CME Term SOFR, B will select a replacement 
for the fallback rate in the first tier of the fallback waterfall based 
on the industry standard at the time of selection. At the time of the 
fallback waterfall's addition, the likelihood that six-month CME Term 
SOFR will be discontinued is remote.
    (2) Analysis of the fallback waterfall. As provided in paragraph 
(h)(3)(i) of this section, B and L must apply the rules in paragraphs 
(h)(3)(iii)(A), (B) and (C) of this section to determine whether the 
fallback waterfall is a qualified rate. Under paragraph (h)(3)(iii)(A) 
of this section, because the rate being tested as a qualified rate 
(i.e., the fallback waterfall) is comprised of more than one

[[Page 179]]

fallback rate, the fallback waterfall is a qualified rate only if each 
individual fallback rate (i.e., fallback rates in the first and second 
tiers of the fallback waterfall) separately satisfies the requirements 
to be a qualified rate. As concluded in paragraphs (h)(3)(iv)(C)(3) and 
(4) of this section, the fallback rates in the first and second tiers 
of the fallback waterfall separately satisfy the requirements to be a 
qualified rate. Therefore, the fallback waterfall is a qualified rate.
    (3) Analysis of the first tier of the fallback waterfall. Because 
the fallback rate in the first tier of the fallback waterfall is the 
same as the fallback rate in paragraph (h)(3)(iv)(A)(1) of this section 
(Example 1), the analysis of the fallback rate in the first tier of the 
fallback waterfall is the same as the analysis of the fallback rate in 
paragraph (h)(3)(iv)(A)(2) of this section (Example 1). Accordingly, 
the fallback rate in the first tier of the fallback waterfall 
separately satisfies the requirements to be a qualified rate.
    (4) Analysis of the second tier of the fallback waterfall. The 
fallback rate in the second tier of the fallback waterfall is the same 
as the fallback rate in paragraph (h)(3)(iv)(B)(1) of this section 
(Example 2). However, unlike the fallback rate in paragraph 
(h)(3)(iv)(B)(1) of this section (Example 2), the likelihood that the 
amount of interest on the debt instrument will ever be determined by 
reference to the fallback rate in the second tier of the fallback 
waterfall is remote. Accordingly, under paragraph (h)(3)(iii)(C) of 
this section, the fallback rate in the second tier of the fallback 
waterfall is treated as satisfying the requirements to be a qualified 
rate.
    (D) Example 4: Addition of a fallback waterfall that is not a 
qualified rate--(1) Facts. The facts are the same as in paragraph 
(h)(3)(iv)(A)(1) of this section (Example 1), except that the new 
fallbacks provide for a fallback waterfall. The first tier of the 
fallback waterfall provides that, upon the discontinuation of six-month 
USD LIBOR, six-month USD LIBOR will be replaced by a stated fallback 
rate (Fallback Rate X). Fallback Rate X, which is equal to an interest 
rate benchmark (Benchmark X) plus a fixed spread, satisfies the 
requirements set forth in the first sentence of paragraph (h)(3)(i) of 
this section. The second tier of the fallback waterfall provides that, 
upon the discontinuation of Benchmark X, B will select a replacement 
for Fallback Rate X based on the industry standard at the time of 
selection. At the time of the fallback waterfall's addition, the 
likelihood that Benchmark X will be discontinued is not remote.
    (2) Analysis of the fallback waterfall. As provided in paragraph 
(h)(3)(i) of this section, B and L must apply the rules in paragraphs 
(h)(3)(iii)(A), (B) and (C) of this section to determine whether the 
fallback waterfall is a qualified rate. Under paragraph (h)(3)(iii)(A) 
of this section, because the rate being tested as a qualified rate 
(i.e., the fallback waterfall) is comprised of more than one fallback 
rate, the fallback waterfall is a qualified rate only if each 
individual fallback rate (i.e., the fallback rates in the first and 
second tiers of the fallback waterfall) separately satisfies the 
requirements to be a qualified rate. As concluded in paragraph 
(h)(3)(iv)(D)(3) of this section, the fallback rate in the second tier 
of the fallback waterfall is treated as not satisfying the requirements 
to be a qualified rate. Therefore, the fallback waterfall is not a 
qualified rate.
    (3) Analysis of the second tier of the fallback waterfall. As 
provided in paragraphs (h)(3)(i) and (h)(3)(iii)(A) of this section, B 
and L must apply the rules in paragraphs (h)(3)(iii)(B) and (C) of this 
section to determine whether the fallback rate in the second tier of 
the fallback waterfall is a qualified rate. Because the likelihood that 
Benchmark X will be discontinued is not remote, paragraph 
(h)(3)(iii)(C) of this section has no effect on the analysis of the 
fallback rate in the second tier of the fallback waterfall. Under 
paragraph (h)(3)(iii)(B) of this section, because it is not possible to 
determine at the time of the fallback waterfall's addition in 2022 
whether the fallback rate in the second tier of the fallback waterfall 
(i.e., the replacement rate that B will select in 2023) satisfies the 
requirements set forth in the first sentence of paragraph (h)(3)(i) of 
this section, the fallback rate in the second tier of the fallback 
waterfall is treated as not satisfying the requirements to be a 
qualified rate.
    (4) Discontinued IBOR. A discontinued IBOR is any interbank offered 
rate described in paragraph (h)(4)(i) or (ii) of this section but only 
during the period beginning on the date of the announcement described 
in paragraph (h)(4)(i) or (ii) of this section and ending on the date 
that is one year after the date on which the administrator of the 
interbank offered rate ceases to provide the interbank offered rate.
    (i) The administrator of the interbank offered rate announces that 
the administrator has ceased or will cease to provide the interbank 
offered rate permanently or indefinitely, and no successor 
administrator is expected as of the time of the announcement to 
continue to provide the interbank offered rate; or
    (ii) The regulatory supervisor for the administrator of the 
interbank offered rate, the central bank for the currency of the 
interbank offered rate, an insolvency official with jurisdiction over 
the administrator for the interbank offered rate, a resolution 
authority with jurisdiction over the administrator for the interbank 
offered rate, a court, or an entity with similar insolvency or 
resolution authority over the administrator for the interbank offered 
rate announces that the administrator of the interbank offered rate has 
ceased or will cease to provide the interbank offered rate permanently 
or indefinitely, and no successor administrator is expected as of the 
time of the announcement to continue to provide the interbank offered 
rate.
    (5) Associated modification. An associated modification is a 
modification of the technical, administrative, or operational terms of 
a contract that is reasonably necessary to adopt or to implement the 
modifications described in paragraph (h)(1)(i), (ii), or (iii) of this 
section other than associated modifications. An associated modification 
also includes an incidental cash payment intended to compensate a 
counterparty for small valuation differences resulting from a 
modification of the administrative terms of a contract, such as the 
valuation differences resulting from a change in observation period. 
Examples of associated modifications include a change to the definition 
of interest period or a change to the timing and frequency of 
determining rates and making payments of interest (for example, 
delaying payment dates on a debt instrument by two days to allow 
sufficient time to compute and pay interest at a qualified rate 
computed in arrears).
    (6) Qualified one-time payment. A qualified one-time payment is a 
single cash payment that is intended to compensate the other party or 
parties for all or part of the basis difference between the 
discontinued IBOR identified in paragraph (h)(1)(i), (ii), or (iii) of 
this section and the interest rate benchmark to which the qualified 
rate refers.
    (i) [Reserved]
    (j) Modifications excluded from the definition of covered 
modification. A modification or portion of a modification described in 
any of paragraphs (j)(1) through (5) of this section is excluded from 
the definition of covered modification in paragraph (h)(1) of this 
section and therefore is a noncovered modification.

[[Page 180]]

    (1) The terms of the contract are modified to change the amount or 
timing of contractual cash flows and that change is intended to induce 
one or more parties to perform any act necessary to consent to a 
modification to the contract described in paragraph (h)(1)(i), (ii), or 
(iii) of this section. See paragraph (j)(6)(iii) of this section 
(Example 3).
    (2) The terms of the contract are modified to change the amount or 
timing of contractual cash flows and that change is intended to 
compensate one or more parties for a modification to the contract not 
described in paragraph (h)(1)(i), (ii), or (iii) of this section. See 
paragraph (j)(6)(v) of this section (Example 5).
    (3) The terms of the contract are modified to change the amount or 
timing of contractual cash flows and that change is either a concession 
granted to a party to the contract because that party is experiencing 
financial difficulty or a concession secured by a party to the contract 
to account for the credit deterioration of another party to the 
contract. See paragraph (j)(6)(vi) of this section (Example 6).
    (4) The terms of the contract are modified to change the amount or 
timing of contractual cash flows and that change is intended to 
compensate one or more parties for a change in rights or obligations 
that are not derived from the contract being modified. See paragraph 
(j)(6)(vii) of this section (Example 7). If each contract in a given 
portfolio of contracts has the same parties, those parties modify more 
than one contract in the portfolio (each such contract is a modified 
portfolio contract), and those modifications provide for a single, 
aggregate qualified one-time payment with respect to all modified 
portfolio contracts, then the portion of the qualified one-time payment 
allocable to any one modified portfolio contract is treated for 
purposes of this paragraph (j)(4) as not intended to compensate for a 
change in rights or obligations derived from any other modified 
portfolio contract.
    (5) The terms of the contract are modified to change the amount or 
timing of contractual cash flows and the modification is identified for 
purposes of this paragraph (j)(5) in guidance published in the Internal 
Revenue Bulletin (see Sec.  601.601(d)(2)(ii)(a) of this chapter) as 
having a principal purpose of achieving a result that is unreasonable 
in light of the purpose of this section.
    (6) Examples. The following examples illustrate the operation of 
the rules in paragraphs (j)(1) through (4) of this section.
    (i) Example 1: Covered modification--(A) Facts. B is the issuer and 
L is the holder of a debt instrument that pays interest semiannually at 
a rate of six-month USD LIBOR plus 100 basis points. On July 1, 2022, B 
and L modify the debt instrument to replace that original rate with CME 
Group's forward-looking SOFR term rate of a six-month tenor (six-month 
CME Term SOFR) plus an adjustment spread of 42.826 basis points plus 
100 basis points (the whole modification is the LIBOR replacement 
modification with basis adjustment spread). B and L chose the 
adjustment spread of 42.826 basis points because that is the adjustment 
spread used or recommended by the International Swaps and Derivatives 
Association and the Alternative Reference Rates Committee for similar 
substitutions or replacements of six-month USD LIBOR with a tenor-
adjusted variant of SOFR.
    (B) Analysis. The parties have modified the terms of the debt 
instrument to replace a rate referencing a discontinued IBOR (i.e., 
six-month USD LIBOR plus 100 basis points) with a qualified rate (i.e., 
six-month CME Term SOFR plus 142.826 basis points). The LIBOR 
replacement modification with basis adjustment spread is described in 
paragraph (h)(1)(i) of this section and not described in any of 
paragraphs (j)(1) through (5) of this section. Therefore, the LIBOR 
replacement modification with basis adjustment spread is a covered 
modification of the debt instrument.
    (ii) Example 2: Covered modification with qualified one-time 
payment--(A) Facts. The facts are the same as in paragraph (j)(6)(i)(A) 
of this section (Example 1), except that, instead of the LIBOR 
replacement modification with basis adjustment spread, B and L modify 
the debt instrument by replacing the original rate of six-month USD 
LIBOR plus 100 basis points with six-month CME Term SOFR plus 100 basis 
points and by obligating B to make a cash payment to L equal to the 
present value of the adjustment spread of 42.826 basis points with 
respect to the debt instrument (this payment is the basis adjustment 
payment, and the whole modification is the LIBOR replacement 
modification with basis adjustment payment).
    (B) Analysis. The parties have modified the terms of the debt 
instrument to replace a rate referencing a discontinued IBOR (i.e., 
six-month USD LIBOR plus 100 basis points) with a qualified rate (i.e., 
six-month CME Term SOFR plus 100 basis points) and have added an 
obligation for B to make the basis adjustment payment, which is a 
single cash payment that is intended to compensate L for the basis 
difference between the discontinued IBOR identified in paragraph 
(h)(1)(i) of this section (i.e., six-month USD LIBOR) and the interest 
rate benchmark to which the qualified rate refers (i.e., six-month CME 
Term SOFR). Accordingly, the basis adjustment payment is a qualified 
one-time payment as defined in paragraph (h)(6) of this section, and 
the LIBOR replacement modification with basis adjustment payment is 
described in paragraph (h)(1)(i) of this section. Because it is 
described in paragraph (h)(1)(i) of this section and not described in 
any of paragraphs (j)(1) through (5) of this section, the LIBOR 
replacement modification with basis adjustment payment is a covered 
modification of the debt instrument.
    (iii) Example 3: Inducement spread--(A) Facts. The facts are the 
same as in paragraph (j)(6)(i)(A) of this section (Example 1), except 
that the debt instrument is part of a widely held issue of debt with 
identical terms. Under the trust indenture applicable to the debt 
instrument, if B proposes a modification of the terms of the debt and 
all holders of the debt consent to that modification, the terms of the 
debt are modified as B proposed. In accordance with the trust 
indenture, B proposes the LIBOR replacement modification with basis 
adjustment spread on January 1, 2022. To induce holders such as L to 
perform the acts necessary to consent to the LIBOR replacement 
modification with basis adjustment spread, B also proposes to increase 
the interest rate paid to each consenting holder by an additional 
spread of 10 basis points (the inducement spread). All holders, 
including L, consent to B's proposed modifications by June 1, 2022. On 
July 1, 2022, the debt instrument is modified to implement the LIBOR 
replacement modification with basis adjustment spread and to increase 
the interest rate by the inducement spread. Once all modifications are 
effective, the debt instrument pays interest at a rate of six-month CME 
Term SOFR plus 152.826 basis points.
    (B) Analysis. As concluded in paragraph (j)(6)(i)(B) of this 
section (Example 1), the portion of these modifications that implements 
the LIBOR replacement modification with basis adjustment spread is a 
covered modification of L's debt instrument. However, the portion of 
these modifications that increases the interest rate by the inducement 
spread changes the amount of cash flows on L's debt instrument, and 
that change is intended to induce L to perform the acts

[[Page 181]]

necessary to consent to a modification to the debt instrument described 
in paragraph (h)(1)(i) of this section (i.e., the LIBOR replacement 
modification with basis adjustment spread). Therefore, the portion of 
the modification that increases the interest rate by the inducement 
spread is described in paragraph (j)(1) of this section and, 
consequently, is a noncovered modification of L's debt instrument. See 
paragraph (b)(2) of this section for the treatment of a contemporaneous 
noncovered modification.
    (iv) Example 4: Consent fee--(A) Facts. The facts are the same as 
in paragraph (j)(6)(iii)(A) of this section (Example 3), except that, 
instead of proposing to increase the interest rate paid to each 
consenting holder by the inducement spread, B proposes to make a cash 
payment to each consenting holder (the consent fee) at the time of the 
modification. Thus, when the proposed modification occurs on July 1, 
2022, B pays all holders, including L, the consent fee. Once all 
modifications are effective, the debt instrument pays interest at a 
rate of six-month CME Term SOFR plus 142.826 basis points.
    (B) Analysis. As concluded in paragraph (j)(6)(i)(B) of this 
section (Example 1), the LIBOR replacement modification with basis 
adjustment spread is a covered modification of L's debt instrument. 
However, B's obligation to pay the consent fee is also a modification 
of L's debt instrument but is not a covered modification because it is 
not described in paragraph (h)(1)(i) of this section. In particular, 
B's obligation to pay the consent fee is not an associated modification 
because it is not a modification of the technical, administrative, or 
operational terms of L's debt instrument and is not intended to 
compensate for valuation differences resulting from a modification of 
the administrative terms of L's contract. Nor is the consent fee a 
qualified one-time payment because it is not intended to compensate L 
for any part of the basis difference between the discontinued IBOR 
identified in paragraph (h)(1)(i) of this section (i.e., six-month USD 
LIBOR) and the interest rate benchmark to which the qualified rate 
refers (i.e., six-month CME Term SOFR). See paragraph (b)(2) of this 
section for the treatment of a contemporaneous noncovered modification.
    (v) Example 5: Compensation for a modification to a customary 
financial covenant--(A) Facts. The facts are the same as in paragraph 
(j)(6)(i)(A) of this section (Example 1), except that, at the same time 
as and for reasons unrelated to the LIBOR replacement modification with 
basis adjustment spread, B and L also modify customary financial 
covenants in the debt instrument in a manner that benefits B. In 
exchange for the modification of customary financial covenants, B 
agrees to add another 30 basis points to the rate such that, once all 
modifications are effective, the debt instrument pays interest at a 
rate of six-month CME Term SOFR plus 172.826 basis points.
    (B) Analysis. As concluded in paragraph (j)(6)(i)(B) of this 
section (Example 1), the portion of these modifications that implements 
the LIBOR replacement modification with basis adjustment spread is a 
covered modification of the debt instrument. However, the portion of 
these modifications that modifies customary financial covenants is not 
related to the replacement of LIBOR and, therefore, is not described in 
any of paragraphs (h)(1)(i), (ii), or (iii) of this section and, 
therefore, is a noncovered modification of the debt instrument. 
Moreover, the portion of these modifications that adds 30 basis points 
to the rate changes the amount of cash flows on the debt instrument, 
and the parties intend that change to compensate L for a modification 
to the debt instrument not described in paragraph (h)(1)(i), (ii), or 
(iii) of this section (i.e., the modification of customary financial 
covenants). Therefore, the portion of these modifications that adds 
those 30 basis points to the rate is described in paragraph (j)(2) of 
this section and, consequently, is a noncovered modification of the 
debt instrument. See paragraph (b)(2) of this section for the treatment 
of a contemporaneous noncovered modification.
    (vi) Example 6: Workout of distressed debt--(A) Facts. The facts 
are the same as in paragraph (j)(6)(i)(A) of this section (Example 1), 
except that B's financial condition has deteriorated since the issue 
date of the debt instrument and, to decrease the risk of B's default or 
bankruptcy, L agrees to subtract 50 basis points from the rate such 
that, once all modifications are effective, the debt instrument pays 
interest at a rate of six-month CME Term SOFR plus 92.826 basis points.
    (B) Analysis. As concluded in paragraph (j)(6)(i)(B) of this 
section (Example 1), the portion of these modifications that implements 
the LIBOR replacement modification with basis adjustment spread is a 
covered modification of the debt instrument. However, the portion of 
these modifications that subtracts 50 basis points from the rate 
changes the amount of cash flows on the debt instrument, and that 
change is a concession granted to B because B is experiencing financial 
difficulty. Therefore, the portion of these modifications that 
subtracts those 50 basis points from the rate is described in paragraph 
(j)(3) of this section and, consequently, is a noncovered modification 
of the debt instrument. See paragraph (b)(2) of this section for the 
treatment of a contemporaneous noncovered modification.
    (vii) Example 7: Change in rights or obligations not derived from 
the modified contract--(A) Facts. B is the issuer and L is the holder 
of a debt instrument (Debt X) with respect to which the facts are the 
same as in paragraph (j)(6)(i)(A) of this section (Example 1). In 
addition, B and L are the issuer and holder, respectively, of a second 
debt instrument (Debt Y). At the same time that the LIBOR replacement 
modification with basis adjustment spread occurs with respect to Debt 
X, B and L also modify customary financial covenants in Debt Y in a 
manner that benefits B. In exchange for the modification of customary 
financial covenants in Debt Y, B agrees to add another 30 basis points 
to the rate on Debt X such that, once all modifications are effective, 
Debt X pays interest at a rate of six-month CME Term SOFR plus 172.826 
basis points.
    (B) Analysis. As concluded in paragraph (j)(6)(i)(B) of this 
section (Example 1), the portion of these modifications that implements 
the LIBOR replacement modification with basis adjustment spread is a 
covered modification of Debt X. However, the portion of these 
modifications that adds 30 basis points to the rate on Debt X changes 
the amount of cash flows on Debt X, and the parties intend that change 
to compensate L for a change in rights or obligations that are not 
derived from Debt X (i.e., the modification of customary financial 
covenants in Debt Y). Therefore, the portion of these modifications 
that adds those 30 basis points to the rate on Debt X is described in 
paragraph (j)(4) of this section and, consequently, is a noncovered 
modification of Debt X. See paragraph (b)(2) of this section for the 
treatment of a contemporaneous noncovered modification.
    (k) Applicability date. This section applies to a modification of 
the terms of a contract that occurs on or after March 7, 2022. A 
taxpayer may choose to apply this section to modifications of the terms 
of contracts that occur before March 7, 2022, provided that the 
taxpayer and all related parties (within the meaning of section 267(b) 
or section 707(b)(1) or within the meaning of Sec.  1.150-1(b) for a 
taxpayer that is a State

[[Page 182]]

or local governmental unit (as defined in Sec.  1.103-1(a)) or a 
501(c)(3) organization (as defined in section 150(a)(4))) apply this 
section to all modifications of the terms of contracts that occur 
before that date. See section 7805(b)(7).

0
Par. 6. Section 1.1271-0 is amended by adding entries for Sec.  1.1275-
2(m) to read as follows:


Sec.  1.12711-0  Original issue discount; effective date; table of 
contents.

* * * * *


Sec.  1.12751-2  Special rules relating to debt instruments.

* * * * *
    (m) Transition from certain interbank offered rates.
    (1) In general.
    (2) Single qualified floating rate.
    (3) Remote contingency.
    (4) Change in circumstances.
    (5) Applicability date.
* * * * *

0
Par. 7. Section 1.1275-2 is amended by adding paragraph (m) to read as 
follows:


Sec.  1.12751 -2  Special rules relating to debt instruments.

* * * * *
    (m) Transition from certain interbank offered rates--(1) In 
general. This paragraph (m) applies to a variable rate debt instrument 
(as defined in Sec.  1.1275-5(a)) that provides both for a qualified 
floating rate that references a discontinued IBOR and for a methodology 
to change that rate referencing a discontinued IBOR to a different rate 
in anticipation of the discontinued IBOR becoming unavailable or 
unreliable. For purposes of this paragraph (m), discontinued IBOR has 
the meaning provided in Sec.  1.1001-6(h)(4). See Sec.  1.1001-6 for 
additional rules that may apply to a debt instrument that provides for 
a rate referencing a discontinued IBOR.
    (2) Single qualified floating rate. If a debt instrument is 
described in paragraph (m)(1) of this section, the rate referencing a 
discontinued IBOR and the different rate are treated as a single 
qualified floating rate for purposes of Sec.  1.1275-5.
    (3) Remote contingency. If a debt instrument is described in 
paragraph (m)(1) of this section, the possibility that the discontinued 
IBOR will become unavailable or unreliable is treated as a remote 
contingency for purposes of paragraph (h) of this section.
    (4) Change in circumstances. If a debt instrument is described in 
paragraph (m)(1) of this section, the fact that the discontinued IBOR 
has become unavailable or unreliable is not treated as a change in 
circumstances for purposes of paragraph (h)(6) of this section.
    (5) Applicability date. Paragraph (m) of this section applies to 
debt instruments issued on or after March 7, 2022. A taxpayer may 
choose to apply paragraph (m) of this section to debt instruments 
issued before March 7, 2022, provided that the taxpayer and all related 
parties (within the meaning of section 267(b) or section 707(b)(1) or 
within the meaning of Sec.  1.150-1(b) for a taxpayer that is a State 
or local governmental unit (as defined in Sec.  1.103-1(a)) or a 
501(c)(3) organization (as defined in section 150(a)(4))) apply 
paragraph (m) of this section to all debt instruments issued before 
that date. See section 7805(b)(7).

0
Par. 8. Section 1.7701(l)-3 is amended by adding a sentence at the end 
of paragraph (b)(2)(ii) to read as follows:


Sec.  1.77011 (l)-3  Recharacterizing financing arrangements involving 
fast-pay stock.

* * * * *
    (b) * * *
    (2) * * *
    (ii) * * * See Sec.  1.1001-6(e) for additional rules that may 
apply to stock that provides for a rate referencing a discontinued 
IBOR, as defined in Sec.  1.1001-6(h)(4).
* * * * *

PART 301--PROCEDURE AND ADMINISTRATION

0
Par. 9. The authority citation for part 301 continues to read in part 
as follows:

    Authority: 26 U.S.C. 7805 * * *


0
Par. 10. Section 301.7701-4 is amended by adding a sentence at the end 
of paragraph (c)(1) to read as follows:


Sec.  301.7701301-4  Trusts.

* * * * *
    (c) * * *
    (1) * * * See Sec.  1.1001-6(f) of this chapter for additional 
rules that may apply to an investment trust that holds one or more 
contracts that provide for a rate referencing a discontinued IBOR, as 
defined in Sec.  1.1001-6(h)(4) of this chapter, and for additional 
rules that may apply to an investment trust with one or more ownership 
interests that reference a discontinued IBOR.
* * * * *

Douglas W. O'Donnell,
Deputy Commissioner for Services and Enforcement.
    Approved: December 19, 2021.
Lily Batchelder,
Assistant Secretary of the Treasury (Tax Policy).
[FR Doc. 2021-28452 Filed 12-30-21; 4:15 pm]
BILLING CODE 4830-01-P