The London Interbank Offered Rate (LIBOR) historically has been used as a key benchmark for a range of financial instruments and contracts with variable interest rates. Due to evidence of manipulation and other issues over the past decade, however, LIBOR is being discontinued, with the publication of non-U.S. dollar-denominated LIBOR rates concluding on Dec. 31, 2021.1 In anticipation of the transition, certain stakeholders, such as industry-specific working groups and regulators, have identified alternative risk-free reference rates (RFRs) to replace LIBOR. These stakeholders, such as the Alternative Reference Rates Committee (ARRC) in the U.S., are responsible for overseeing the transition to each individual RFR.
Working groups and other relevant authorities, such as the International Swaps and Derivatives Association (ISDA), have released specific guidance to assist organizations with updating contracts affected by the transition, including updated fallback language to be used in the event that the selected benchmark rate is permanently discontinued or is otherwise determined to be nonrepresentative of its underlying market.
Due to its widespread use and versatility, LIBOR often is embedded throughout an organization’s operations (such as in legal agreements and internal financial models) and, accordingly, companies must be proactive about addressing the LIBOR transition and identifying any associated risks. The LIBOR transition has broad implications. While these changes might be only one of many issues on a list of competing priorities for most organizations, they have the potential to affect a number of existing functions including, for tax purposes, the arm’s-length nature of certain intercompany transactions or arrangements (for instance, a loan from a parent to a subsidiary with an interest rate based on LIBOR plus a margin).
As a result of transitioning from LIBOR, taxpayers should review their transfer pricing analyses and associated support to determine if any updates are necessary, including whether to prepare revised transfer pricing documentation or agreements. Following are five steps companies should consider from a transfer pricing perspective.
1. Identify LIBOR exposure
Organizations should review if their existing intercompany agreements or contracts reference LIBOR. In some cases, formal agreements or contracts might not currently exist, though LIBOR may still be used as basis for important determinations such as determining the interest rate on an intercompany loan. Companies also should consider formally memorializing intercompany arrangements and terms that have not previously been formally documented in light of the LIBOR transition.
2. Determine the appropriate RFR to replace LIBOR
If a LIBOR exposure is identified, companies should review the available alternative RFRs, understand their individual characteristics, and identify how current arrangements would be affected by each. RFRs have distinct characteristics and are overseen by different administrators, so organizations should review the information released by the relevant authorities to determine the appropriate rate to replace LIBOR.