On June 29, 2023, the IRS published final regulations that provide the appropriate reference rate to be used by a foreign bank that elects to use a published rate to determine the amount of excess interest expense allocable to income that is effectively connected with a trade or business within the United States (“ECI”).  The regulations replace the 30-day interbank offered rate (“IBOR”) with a 30-day secured overnight financing rate (“SOFR”), plus a recommended static spread adjustment of 0.11448% to account for differences between IBOR and SOFR — the same spread adjustment as the one prescribed under the Adjustable Interest Rate (LIBOR) Act of 2021 (the “LIBOR Act”).

To put this change in context, the regulations under Code Section 882 permit foreign banks with excess U.S.-connected liabilities to increase the amount of interest expense allocable to ECI by an amount that reflects the average cost of borrowing in USD.  A bank may elect to use the published rate prescribed in the regulations rather than compute the actual rate on its own excess U.S.-connected liabilities.  Prior to these regulations, the published rate was a 30-day IBOR.  Final regulations published on January 4, 2022 (discussed here) sought comments from the public on the use of a SOFR-based rate in this context.  The new regulations adopt the recommendation to use a monthly SOFR plus the spread adjustment prescribed under the LIBOR Act.  Notably, the IRS rejected other recommendations that would have allowed a taxpayer to approximate their actual rate of borrowing or that would have allowed the IRS to identify additional qualified alternative rates.