[Federal Register Volume 88, Number 125 (Friday, June 30, 2023)]
[Rules and Regulations]
[Pages 42231-42234]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2023-13890]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 9976]
RIN 1545-BO91


Additional Guidance on the Transition From Interbank Offer Rates 
to Other Reference Rates With Respect to the Interest Rates of a 
Foreign Bank

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

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SUMMARY: This document contains additional final regulations that 
provide guidance on the transition away from the use of interbank offer 
rates (``IBORs'') to other reference rates. Specifically, this 
regulation provides the replacement rate for the IBOR presently used in 
the published rate election, which may be used by taxpayers to 
determine the amount of interest expense attributable to their excess 
U.S.-connected liabilities and allocable to income that is effectively 
connected with the conduct of a trade or business within the United 
States (``ECI''). The final regulations will affect foreign banks that 
have income that is ECI.

DATES: 
    Effective date: This regulation is effective on June 30, 2023.
    Applicability date: For dates of applicability, see Sec.  1.882-
5(f)(3).

FOR FURTHER INFORMATION CONTACT: D. Peter Merkel or Caleb W. Trimm, 
(202) 317-6938 (not a toll-free number).

SUPPLEMENTARY INFORMATION: 

Background

    This document contains final regulations that provide for the 
replacement of the 30-day IBOR rate presently referenced by Sec.  
1.882-5(d)(5)(ii)(B) with the Secured Overnight Financing Rate 
(``SOFR'') of the same tenor, plus a fixed spread adjustment.

I. Discontinuation of IBORs and Transition to SOFRs

    The London Interbank Offered Rate (``LIBOR'') is an interest rate 
benchmark that was the dominant reference rate used in financial 
contracts, at one point serving as the benchmark for more than $200 
trillion of contracts worldwide. On July 27, 2017, the Financial 
Conduct Authority, the United Kingdom regulator tasked with overseeing 
LIBOR, announced that publication of all currency and term variants of 
LIBOR, including the U.S. dollar LIBOR (``USD LIBOR''), may cease after 
the end of 2021. On March 5, 2021, the administrator of LIBOR, 
Intercontinental Exchange (ICE) Benchmark Association, announced that 
publication of the overnight, one-month, three-month, six-month, and 
12-month USD LIBORs would cease following the LIBOR publication on June 
30, 2023. The ICE Benchmark Association will continue to publish an 
unrepresentative synthetic USD LIBOR in one-month, three-month, and 
six-month tenors until September 30, 2024.\1\ Publication of all other 
currency and tenor variants of LIBOR (including the one-week and two-
month USD LIBOR) ceased following the LIBOR publication on December 31, 
2021.
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    \1\ The synthetic USD LIBOR will be the Term SOFR of the same 
tenor (published by the Chicago Mercantile Exchange Group Benchmark 
Administration, Ltd.), plus a fixed spread adjustment of 0.11448%, 
0.26161%, or 0.42826% for the one-, three-, and six-month tenors, 
respectively. Financial Conduct Authority, Article 23D Benchmarks 
Regulation Draft Notice of Requirements (April 3, 2023), https://www.fca.org.uk/publication/libor-notices/article-23d-benchmarks-regulation-usd-draft-notice-requirements.pdf. This rate is not 
considered representative because it uses a synthetic methodology to 
determine rates instead of the panel bank methodology that has 
historically been used to determine IBORs.
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    The Alternative Reference Rate Committee (``ARRC''), whose ex 
officio members include the Board of Governors of the Federal Reserve 
System, the Department of the Treasury (``Treasury Department''), the 
Commodity Futures Trading Commission, and the Office of Financial 
Research, was convened by the Board of Governors of the Federal Reserve 
System and the Federal Reserve Bank of New York to identify alternative 
reference rates that would be both more robust than USD LIBOR and that 
would comply with standards such as the International Organization of 
Securities Commissions' ``Principles for Financial Benchmarks.'' In 
2017, the ARRC identified a SOFR-based rate as its recommended 
replacement for LIBOR.
    In 2021, the ARRC recommended the forward-looking term SOFRs 
published by the Chicago Mercantile Exchange Group Benchmark 
Administration, Ltd. in one-month, three-month, and six-month tenors. 
The ARRC has also recommended static spread adjustments to each of 
those tenors to adjust for the fact that SOFRs are risk-free rates, 
while IBORs include an element of bank credit risk. The static spread 
adjustments are based on the historical median over a 5-year lookback 
period calculating the difference between USD LIBOR and compounded 
averages of SOFR, set on

[[Page 42232]]

March 5, 2021.\2\ The recommended static spread adjustment for one-
month SOFR is 0.11448%.
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    \2\ For an explanation of the SOFR averaging calculation, see 
Federal Reserve Bank of New York, Additional Information About the 
Reference Rates Administered by the New York Fed, https://www.newyorkfed.org/markets/reference-rates/additional-information-about-reference-rates.
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    To support the transition away from USD LIBOR, the ARRC has 
published recommended fallback language for inclusion in the terms of 
certain cash products. Contracts governed by U.S. law that reference 
USD LIBOR but that do not have any (or that have inadequate) fallback 
provisions are generally required by the Adjustable Interest Rate Act 
(``LIBOR Act''), Public Law 117-103, div. U, to use the SOFR of the 
same tenor, plus a static spread adjustment. The static spread 
adjustments to SOFR for each USD tenor required by the LIBOR Act are 
the same as those recommended by the ARRC.

II. Regulatory Background

    The transition from IBORs to SOFRs or other reference rates may 
give rise to various tax issues. To minimize market disruption and 
facilitate an orderly transition in connection with the discontinuation 
of LIBOR and other IBORs, the Treasury Department and IRS published 
proposed regulations (REG-118784-18) in the Federal Register (84 FR 
54068) on October 9, 2019 (``2019 Proposed Regulations'').
    One issue addressed by the 2019 Proposed Regulations was the 
election provided by Sec.  1.882-5(d)(5)(ii)(B). A foreign corporation 
that has a U.S. branch or other trade or business within the United 
States applies Sec.  1.882-5 to determine its interest expense 
allocable under section 882(c) to its ECI. If a foreign corporation 
uses the method described in Sec.  1.882-5(b) through (d), that foreign 
corporation could have liabilities attributable to its U.S. branch 
(U.S.-connected liabilities) that exceed its U.S.-booked liabilities 
(excess U.S.-connected liabilities). When a foreign corporation has 
excess U.S.-connected liabilities, Sec.  1.882-5(d)(5)(ii)(A) entitles 
the foreign corporation to increase its interest expense allocable to 
its ECI in an amount determined by reference to the average U.S.-dollar 
borrowing cost on all U.S.-dollar liabilities other than its U.S.-
booked liabilities. If the foreign corporation is a bank, it may elect 
under Sec.  1.882-5(d)(5)(ii)(B) to use a published average 30-day 
LIBOR for the year rather than the actual rate computed under Sec.  
1.882-5(d)(5)(ii)(A). Because use of that election will no longer be 
possible when LIBOR is phased out, the 2019 Proposed Regulations 
included a proposal to replace 30-day USD LIBOR referenced in Sec.  
1.882-5(d)(5)(ii)(B) with a yearly average SOFR. Because SOFR is an 
overnight risk-free rate, the Treasury Department and the IRS 
acknowledged that the yearly average SOFR was likely to result in a 
lower rate than the 30-day LIBOR calculation previously allowed under 
Sec.  1.882-5(d)(5)(ii)(B) and requested comments on whether another 
rate might be more appropriate.
    Following publication of the 2019 Proposed Regulations, the 
Treasury Department and the IRS received one comment regarding the 
proposal to use yearly average SOFR in place of 30-day USD LIBOR for 
the election available under Sec.  1.882-5(d)(5)(ii)(B). The comment 
noted two key differences between 30-day LIBOR and the yearly average 
SOFR, which the commenter stated made the yearly average SOFR an 
inappropriate substitute for 30-day LIBOR. First, SOFR is a risk-free 
rate, while LIBOR is an unsecured rate. Second, SOFR is an overnight 
rate, while the 30-day LIBOR is a one-month rate. The comment noted 
that SOFR removes the credit risk premium and term liquidity premium 
from the cost of borrowing as compared to 30-day LIBOR. The comment, 
however, did not identify a more reasonable substitute for 30-day LIBOR 
at that time and recommended that the Treasury Department and the IRS 
defer finalizing the proposed rule under Sec.  1.882-5(d)(5)(ii)(B) 
because a yearly average SOFR calculation was not a reasonable 
replacement rate for 30-day USD LIBOR.
    On January 4, 2022, the Treasury Department and the IRS published 
final regulations (TD 9961) in the Federal Register (87 FR 166) 
relating to the transition from IBORs to other reference rates (``2022 
Final Regulations''). The 2022 Final Regulations did not finalize the 
proposed change to Sec.  1.882-5(d)(5)(ii)(B). Instead, the Treasury 
Department and the IRS sought additional comments regarding the 
appropriate replacement rate for 30-day USD LIBOR for the purpose of 
the election under Sec.  1.882-5(d)(5)(ii)(B).
    Following the publication of the 2022 Final Regulations, the 
Treasury Department and the IRS received one additional comment 
regarding the appropriate replacement rate for the 30-day USD LIBOR 
rate referenced by Sec.  1.882-5(d)(5)(ii)(B).
    This comment is 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 comments, the Treasury 
Department and the IRS adopt the 2019 Proposed Regulation as amended by 
this Treasury decision (``final regulations'').

Summary of Comments and Explanation of Revisions

I. Appropriate Replacement Rate for 30-Day LIBOR

    In response to the request for additional comments in TD 9961, one 
comment was received relating to the 30-day USD LIBOR replacement in 
Sec.  1.882-5(d)(5)(ii)(B). The comment made three recommendations for 
the final regulations under Sec.  1.882-5(d)(5)(ii)(B).
A. One-Month Term SOFR Plus a Static Spread Adjustment
    First, the comment recommended finalizing the regulation using the 
one-month term SOFR plus static spread adjustment of 0.11448% as 
recommended by the ARRC (which endorsed Term SOFR rates in June of 2021 
and spread adjustments in October of 2021) and codified in the LIBOR 
Act (enacted in December of 2021). The comment noted that the one-month 
term SOFR plus a fixed spread adjustment accounts for some of the 
differences between SOFR and LIBOR rates and implied that one-month 
term SOFR plus static spread adjustment of 0.11448% is a more 
appropriate replacement than yearly average SOFR. The published rate 
election provides eligible taxpayers with administrative relief from 
the burden of calculating their actual borrowing rate, which is based 
on data maintained outside the United States.
    The final regulations adopt this recommendation. The ARRC, whose ex 
officio members include the Treasury Department, has generally 
recommended that contracts referencing USD LIBOR adopt fallback 
provisions that reference the term SOFR of the same tenor, plus a 
static spread adjustment. The Treasury Department has supported the 
recommendations of the ARRC in prior guidance issued in Revenue 
Procedure 2020-44, 2020-45 I.R.B. 991 and the 2022 Final Regulations. 
In addition, contracts governed by U.S. law that have not voluntarily 
adopted such fallback provisions are generally required by the LIBOR 
Act to use the SOFR of the same tenor, plus the ARRC-recommended static 
spread adjustment, as a matter of law. Public Law 117-103, div. U. 
Accordingly, both the Treasury Department and the U.S. Congress have 
endorsed, or required, the use of a term SOFR of the same tenor, plus 
the ARRC-recommended static spread adjustment, as a replacement for 
term USD LIBORs. Because the published rate election

[[Page 42233]]

available under Sec.  1.882-5(d)(5)(ii)(B) references 30-day LIBOR, the 
one-month term SOFR (plus static spread adjustment) is the most 
appropriate replacement rate.
B. Alternative Method Approximating Actual Rate
    The comment also recommended that the final regulations allow 
taxpayers to use a rate that reasonably approximates the bank's actual 
rate and that is consistently applied from year to year. This 
recommendation is based on the approach taken in regulations that were 
in effect from 1981 through 1996. TD 7749, 46 FR 1681 (Jan. 7, 1981) 
(codified at former Sec.  1.882-5(b)(3)(i)(B)). This historical 
regulation provided that, if information needed to calculate the 
taxpayer's actual interest rate could not be reasonably obtained, then 
the taxpayer could determine its interest rate by applying any method 
that reasonably approximated its actual interest rate and that was 
consistently applied year over year, including, for example, 
approximating its interest rate by reference to 30-day LIBOR. Id. at 
1684-85. The comment expressed concern that the one-month term SOFR 
plus static spread adjustment may be less than the actual cost of 
borrowing; however, for some taxpayers it may not be worthwhile or 
possible for the corporation to calculate its actual borrowing rate.
    The final regulations do not adopt this recommendation. An approach 
based on a reasonable approximation of a taxpayer's actual interest 
would establish a different method for determining a taxpayer's 
borrowing rate that does not provide the certainty, accuracy, and 
simplicity of a published rate election. Additionally, the IRS would 
face significant challenges in administering such a rule. For example, 
the comment did not suggest any standard by which the IRS might 
determine whether a taxpayer's method is a reasonable approximation of 
its actual borrowing rate.
    Finally, data from recent filing years indicates that the actual 
rate calculation is not a significant burden to taxpayers. For taxable 
years 2020 and 2021 (the most recent years for which data is 
available), a majority of foreign banks with excess U.S.-connected 
liabilities chose to calculate their actual rate rather than use the 
published rate election. In both years, approximately 80% of such 
taxpayers opted to calculate their actual rate, while less than 20% 
chose to use the published rate election available under Sec.  1.882-
5(d)(5)(ii)(B).
C. Mechanism for Endorsing Additional Replacement Rates
    Finally, the comment recommended that the final regulations include 
a mechanism for identifying additional qualified alternative reference 
rates via Internal Revenue Bulletin, Revenue Procedure, or another 
similar notice. The final regulations do not adopt this recommendation. 
The Treasury Department and the IRS do not anticipate a need to name 
additional alternative reference rates, and, if the need does arise in 
the future, the Treasury Department and the IRS may prefer to propose 
any new alternative reference rate through the regulatory process.

II. Application of the Published Rate Election by the IRS in an 
Examination

    If a taxpayer failed to file a timely return or incorrectly 
determined that it did not have excess U.S.-connected liabilities, 
Sec.  1.882-5(d)(5)(ii)(B) allowed the Director of Field Operations to 
calculate the taxpayer's interest expense with respect to excess U.S.-
connected liabilities using either the taxpayer's actual rate or the 
published rate provided by Sec.  1.882-5(d)(5)(ii)(B). The final 
regulations amend this rule to require the Director of Field Operations 
to use the published rate in order to reduce the administrative burden 
of calculating the actual rate for both the IRS and taxpayers.

III. Transitional Rule for Taxable Years Including the Date of LIBOR 
Cessation

    For a taxable year that begins before and ends after the USD LIBOR 
cessation date of June 30, 2023, a taxpayer that makes the published 
rate election available under Sec.  1.882-5(d)(5)(ii)(B) must calculate 
a blended published rate average for the taxable year which uses the 
30-day USD LIBOR for the portion of its taxable year ending on June 30, 
2023, and the one-month Term SOFR, plus static spread adjustment, for 
the portion of its taxable year beginning on July 1, 2023.

IV. Applicability Date

    These final regulations apply to taxable years ending after June 
30, 2023.

Special Analyses

I. Regulatory Planning and Review--Economic Analysis

    Pursuant to the Memorandum of Agreement, Review of Treasury 
Regulations under Executive Order 12866 (June 9, 2023), tax regulatory 
actions issued by the IRS are not subject to the requirements of 
section 6 of Executive Order 12866, as amended. Therefore, a regulatory 
impact assessment is not required.

II. Regulatory Flexibility Act

    The final regulations affect any foreign bank that has ECI and that 
has excess U.S.-connected liabilities, but which cannot reasonably 
calculate its actual borrowing rate. The number of small entities 
potentially affected by the final regulations is unknown; however, it 
is unlikely to be a substantial number because the final regulations 
only affect foreign banks that operate in the United States. In 
addition, data collected from Forms 1120-F, Schedule I filed in recent 
taxable years indicates that fewer than 100 total taxpayers are foreign 
banks with both ECI and excess U.S-connected liabilities. The data from 
Forms 1120-F, Schedule I shows that the number of foreign banks that 
elected to use the 30-day USD LIBOR rate to compute the interest 
expense attributable to their excess U.S.-connected liabilities varied 
from year to year. In some years, as many as 50 foreign banks made the 
election on Schedule I to use the 30-day USD LIBOR rate; in other 
years, fewer than ten taxpayers made that election. The Secretary has 
determined that the economic impact on any small entities affected by 
the final regulations is not significant.
    The final regulations provide that the annual published rate 
election available under Sec.  1.882-5(d)(5)(ii)(B) will be modified by 
substituting the one-month term SOFR, plus a static spread adjustment, 
for 30-day USD LIBOR. The rule does not require taxpayers to collect 
additional information to determine whether the taxpayer is eligible 
for the election. Additionally, the rule does not impose any new costs 
on taxpayers because it only replaces the published rate used for the 
purpose of the election and does not affect a taxpayer's obligation 
with respect to the information to be gathered and reported.
    In accordance with the Regulatory Flexibility Act (5 U.S.C. 601 et 
seq.) the Secretary hereby certifies that these final regulations will 
not have a significant economic impact on a substantial number of small 
entities.

III. Section 7805(f)

    Pursuant to section 7805(f), the proposed regulations (REG-118784-
18) preceding these final regulations were submitted to the Chief 
Counsel for Advocacy of the Small Business Administration for comment 
on the impact on small business, and no comments were received.

[[Page 42234]]

IV. 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. This rule does 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.

V. 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. This regulation does not have 
federalism implications and does not impose substantial direct 
compliance costs on state and local governments or preempt state law 
within the meaning of the Executive order.

Statement of Availability of IRS Documents

    IRS Notices and other guidance cited in this preamble are published 
in the Internal Revenue Bulletin (or Cumulative Bulletin) and are 
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.

Drafting Information

    The principal authors of these regulations are D. Peter Merkel and 
Caleb W. Trimm of the Office of Associate Chief Counsel 
(International). However, other personnel from the IRS and Treasury 
Department participated in their development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

    Accordingly, the Treasury Department and IRS amend 26 CFR part 1 as 
follows:

PART 1--INCOME TAXES

0
Paragraph 1. The authority citation for part 1 is amended by revising 
the entry for Sec.  1.882-5 to read in part as follows:

    Authority:  26 U.S.C. 7805 * * *
* * * * *
    Section 1.882-5 also issued under 26 U.S.C. 882(c), 26 U.S.C. 
864(e), 26 U.S.C. 988(d), and 26 U.S.C. 7701(l).
* * * * *

0
Par. 2. Section 1.882-5 is amended by revising the fourth sentence of 
paragraph (a)(7)(i) and paragraphs (d)(5)(ii)(B) and (f) to read as 
follows:


Sec.  1.882-5  Determination of interest deduction.

    (a) * * *
    (7) * * *
    (i) * * * An elected method (other than the fair market value 
method under paragraph (b)(2)(ii) of this section, or the published 
rate election in paragraph (d)(5)(ii) of this section) must be used for 
a minimum period of five years before the taxpayer may elect a 
different method. * * *
* * * * *
    (d) * * *
    (5) * * *
    (ii) * * *
    (B) Annual published rate election--(1) In general. For each 
taxable year in which a taxpayer is a bank within the meaning of 
section 585(a)(2)(B) (without regard to the second sentence of section 
585(a)(2)(B) or whether any such activities are effectively connected 
with a trade or business within the United States), the taxpayer may 
elect to compute the interest expense attributable to excess U.S.-
connected liabilities by using the average published one-month Term 
Secured Overnight Financing Rate published by the Chicago Mercantile 
Exchange Group Benchmark Administration, Ltd. (or any successor 
administrator) (``Term SOFR'') for the taxable year, plus a static 
spread adjustment of 0.11448%, rather than the interest rate provided 
in paragraph (d)(5)(ii)(A) of this section. A taxpayer may elect to 
apply the rate provided in this paragraph (d)(5)(ii)(B) on an annual 
basis and does not require the consent of the Commissioner to change 
this election in a subsequent taxable year. If a taxpayer that is 
eligible to make the published rate election either does not file a 
timely return or files a calculation with no excess U.S.-connected 
liabilities and it is later determined by the Director of Field 
Operations that the taxpayer has excess U.S.-connected liabilities, 
then the Director of Field Operations will apply the interest rate 
provided under this paragraph (d)(5)(ii)(B) to the taxpayer's excess 
U.S.-connected liabilities in determining interest expense.
    (2) Transitional rule for taxable years including June 30, 2023. 
For a taxable year that includes June 30, 2023, a taxpayer that makes 
the annual published rate election must compute the interest expense 
attributable to excess U.S.-connected liabilities by ratably using the 
average 30-day U.S. dollar London Interbank Offered Rate for the 
portion of its taxable year ending on June 30, 2023, and the average 
one-month Term SOFR, plus a static spread adjustment of 0.11448%, for 
the portion of its taxable year beginning on July 1, 2023.
* * * * *
    (f) Applicability date--(1) General rule. Except as provided in 
paragraph (f)(3) of this section, this section is applicable for tax 
years ending on or after August 15, 2009. A taxpayer, however, may 
choose to apply Sec.  1.882-5T, rather than applying the regulations in 
this section, for any taxable year beginning on or after August 16, 
2008, but before August 15, 2009.
    (2) [Reserved]
    (3) Applicability date for published rate election. Paragraphs 
(a)(7)(i) and (d)(5)(ii)(B) of this section apply to taxable years 
ending after June 30, 2023. For taxable years ending before July 1, 
2023, see Sec.  1.882-5(d)(5)(ii)(B) (as contained in 26 CFR part 1, 
revised as of April 1, 2023).

Douglas W. O'Donnell,
Deputy Commissioner for Services and Enforcement.
    Approved: June 19, 2023.
Lily Batchelder,
Assistant Secretary of the Treasury (Tax Policy).
[FR Doc. 2023-13890 Filed 6-29-23; 8:45 am]
BILLING CODE 4830-01-P