Notional principal contract swaps with nonperiodic payments; embedded loan rule

Temporary regulations, notional principal contracts

The Treasury Department and IRS today released for publication in the Federal Register correcting amendments to temporary regulations issued in May 2015. These amendments to the 2015 temporary regulations concern the treatment of nonperiodic payments made or received under certain notional principal contracts, by changing the applicability date of the “embedded loan rule” for the treatment of nonperiodic payments—the date is delayed from November 4, 2015, to the later of: (1) January 1, 2017; or (2) six months after the date of publication in the Federal Register of regulations that finalize these rules as final regulations.

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Read text of the correcting amendments [PDF 194 KB] to the temporary regulations.

temporary regulations

Temporary regulations (T.D. 9719) released in May 2015 addressed the treatment of nonperiodic payments made or received under certain notional principal contracts. Specifically, the May 2015 temporary regulations:

  • Amended the regulations issued under section 446 relating to the treatment of nonperiodic payments made or received under certain notional principal contracts
  • Generally provided that, with certain exceptions, a notional principal contract with a nonperiodic payment—whether the payment is determined to be significant or not—must be treated as two separate transactions consisting of one or more loans and an on-market, level payment swap
  • Amended the definition of “United States property” under section 956 by providing an exception

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According to the preamble to today’s correcting amendments, a provision in the May 2015 temporary regulations—Reg. section 1.446-3T(g)(4)(i)—provided that (with certain exceptions) a notional principal contract with one or more nonperiodic payments is treated as two separate transactions consisting of an on-market, level payment swap and one or more loans—referred to as the “embedded loan rule.” The temporary regulations eliminated the previous exception to the embedded loan rule for non-significant, nonperiodic payments (this exception had been provided in 1993 regulations). The measure eliminating the exception was set to apply to notional principal contracts entered into on or after November 4, 2015. 

Date applicable, changed

After publication of the temporary regulations in May 2015, the IRS and Treasury received comments requesting a delay of the date when the change to the embedded loan rule would apply. In response to these comments, the IRS and Treasury today issued a correcting amendment, to revise the applicability date. 

Accordingly, the change to the embedded loan rule in Reg. section 446-3T(g)(4)(i) and Reg. section 1.446-3T (g)(6), Example 2, applies to notional principal contracts entered into on or after the later of: (1) January 1, 2017; or (2) 180 days after the date of publication of the Treasury decision adopting these rules as final regulations in the Federal Register. 

Today’s release provides that before that applicability date, taxpayers may continue to apply the 1993 regulations that (except for purposes of section 956) limit the application of the embedded loan rule to nonperiodic payments that are significant.

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