The transition of the Interbank Offered Rates (IBORs) starts from the end of 2019/2021 and will have a significant impact across multiple areas such as technology, operations, risk, legal, accounting and tax. Authors: Vincent Grandjean, Luis Sanchez
- Ahead of the discontinuation of Interbank Offered Rates (IBORs) that starts from the end of 2019/2021, the transition towards alternative reference rate (ARR) benchmarks has already begun.
- While the tax assessment of the IBOR transition impact has just started, the first direct and indirect implications are already emerging.
- Based on our initial assessment, there are implications for tax documentation and tax rulings, tax accounting (triggered by misalignments due to the revaluation of transactions/assets), cross-border transactions as well as direct and indirect taxes.
- Given the complex nature of multinationals, specifically when introducing far-reaching initiatives such as renegotiating global contracts, novating financing agreements or updating tax rulings with authorities, immediate action should be taken by taxpayers and authorities to fully develop, understand and prepare for the changes that the IBOR transition will generate in the tax context.
IBORs have served for decades as reference rates for financial market participants among a wide range of financial products. One of the most relevant IBORs, the London Interbank Offered Rate (LIBOR), which is published for five currencies including the Swiss Franc (CHF), became and still is the predominant interest rate benchmark for a significant number of financial contracts in Switzerland. As it is becoming more certain that from the end of 2021 LIBOR will be phased out, several working groups in different jurisdictions have made progress in identifying ARR benchmarks, in an attempt to limit the transition risk in a post-IBOR era. While some of the key themes and challenges in areas such as Valuation and Legal have already been identified, the list of potential impacts continues to grow with many tax topics not being added.
Switzerland has already selected a suitable ARR option. In October 2017, the working group on CHF reference rates concluded that the Swiss Average Rate Overnight (SARON) is the best alternative to CHF LIBOR. The SARON index was launched in 25 August 2009 (with historical data starting June 1999) in cooperation between the Swiss National Bank and the SIX Swiss Stock Exchange and, unlike LIBOR, it is based on secured assets. Its market volume has been growing steadily since its creation – between 2015 and 2017 its average volume was approximately CHF 7.5 billion – and it is expected in the future to become the single reference benchmark rate for all interest rate products denominated in CHF such as derivatives, structured products, loans, mortgages, or bonds, among others.
From a tax angle, it is fair to say that the assessment of the IBOR transition impact has just started and it is still too early to list all of its possible implications. However, it is likely to include impacts on areas such as tax accounting, cross-border transactions, tax reporting, international tax and transfer pricing. For example, aside from the transaction costs and obstacles inherent to any renegotiation process, the change from IBOR to ARR may generate a potential increase/decrease in the value of certain financial products referencing IBORs, which may be taxable/deductible depending on how the potential gain/loss will be booked in the statutory financial statements. At the current stage, the approach to be taken when reevaluating financial products is uncertain; in general terms, tax authorities will follow the accounting standards to evaluate the products from a tax perspective. Therefore, a decrease in the value of the asset may also result in a depreciation from a tax perspective, whereas an increase in the value would not have an immediate direct impact (with specific exceptions), since its value increase would only be booked once the financial product is transferred.
Similar problems could also be faced with the “tax rulings”, i.e. agreements negotiated between taxpayers and the Swiss tax authorities in order to evaluate the tax implications of a particular transaction or situation and achieve tax certainty. Some tax rulings may refer to IBORs, for example when trying to determine the effective rate of intercompany loans, and under the new scenario all these IBOR-linked agreements will need to be amended or renegotiated. In the standard process, a tax ruling request is paired with supporting documentation explaining the circumstances of the relevant transaction or entity. Hence, an updated supporting write-up has to be prepared under the new ARR standard and submitted for review, discussion and approval by the authorities. However, given the large amount of requests and the bespoke and technical nature of these updates, it is reasonable to expect that the average time to get an initial response will increase from the existing two to three month period.
In addition, transitioning from a single reference rate model, such as IBORs, into a system with multiple ARRs could result in new cross border issues. There is a possibility that in the future, where one jurisdiction has accepted the pricing of a cross-border transaction following its ARR of reference rate, a different jurisdiction might arrive at a different price by applying a different ARR, thus creating a double taxation scenario. Although the ARRs identified so far adhere to the Principles for Financial Benchmarks published by the International Organization of Securities Commissions (IOSCO) and follow the recommendations made by the Financial Stability Board (FSB), the risk of double taxation might increase, since coordination between tax authorities among different international locations could be insufficient.
This situation could also have implications on Transfer Pricing, as Transfer Pricing documentation will need to be updated in order to assess which policies, methodologies, benchmarks and other supporting documents are compliant with the new ARRs. This will also imply reshaping how intragroup financing tools are priced, in areas such as cash-pooling, guarantee fees, hedging or captive insurance.
Aside from the tax examples previously mentioned, there are also implications from a legal, accounting, operational or regulatory perspective, to name just a few. On the tax front, multiple efforts are currently on-going to fully identify and understand key topics, impacts, implications and actions required, while trying to increase the awareness on this topic among taxpayers and authorities. What it is certain is that in order to have a smooth transition into the new model, it is expected that authorities familiarize with themselves with the topic, taxpayers initiate their internal due diligence in the coming months to ensure that impacted areas are properly identified (tax rulings, changes in valuation of instruments/assets, transfer pricing documentation, etc.) and clear action items for the coming months/years are introduced.
In case of further queries, please reach out to us. We will be happy to walk you through the potential impacts and our solutions, helping you to design a risk map and action plan suitable to your circumstances.
What EY can do to help? EY can assist with:
- Guidance, support and training on this topic;
- Establishing a governance structure and setting up an IBOR program steering committee with a specific work stream for tax issues;
- Running an impact assessment across the impacted areas using an established defined tax assessment methodology; and
- Performing a review of tax documentation and related inventories
 EUR benchmarks/LIBOR.