The Treasury Department and IRS announced in Notice 2025-63 (Notice) that forthcoming proposed regulations would source "borrow fees" or "negative rebates" (collectively, "borrow fees") paid with respect to securities lending and sale-repurchase transactions to the residence of the recipient.

Background

A 30% withholding tax generally applies to payments of US-source fixed or determinable, annual or periodical (FDAP) income to a foreign person. Neither the Internal Revenue Code (IRC) nor Treasury Regulations directly address how borrow fees should be sourced for income tax purposes. As a result, the appropriate source rule for those payments is uncertain and, withholding may apply if they are considered US source.

While some US-based financial institutions choose not to withhold on these payments to non-US persons, those that do have argued that withholding puts them at a disadvantage to their non-US-based competitors. The Notice announces that the Treasury Department and the IRS intend to issue proposed regulations on the sourcing of borrow fees and permits taxpayers to rely on this position until those regulations are issued.

Notice 2025-63

The Notice states that the forthcoming proposed regulations will provide for recipient-based sourcing on borrow fees paid with respect to a securities lending transaction or a sale-repurchase transaction. Fees determined to be non-US source under such regulations would not be subject to withholding under Chapters 3 and 4.

The borrow fees governed by the proposed regulations would be those meeting the following requirements:

1. The fees are paid pursuant to a securities lending transaction or sale-repurchase transaction that is:
1. Documented on an industry-standard "master agreement¹ and confirmation" with standard market terms
2. Entered in the ordinary course of the taxpayer's and counterparty's trades or businesses or pursuant to their normal investment activities or objectives
2. The fees are paid in substance to compensate the lender of the securities (including a cash borrower in a sale-repurchase transaction) for making its securities available to the borrower of the securities (including a cash lender in a sale-repurchase transaction)

For this purpose, a securities lending transaction is defined as a transfer of securities that is described in IRC Section 1058 or a substantially similar transaction. Further, a sale-repurchase transaction is defined as an agreement under which a person transfers a security in exchange for cash and simultaneously agrees to receive substantially identical securities from the transferee in the future in exchange for cash.

Applicability

Taxpayers may rely on the rules described in the Notice until the proposed regulations are published in the Federal Register. The proposed regulations would provide that the regulations will apply prospectively to tax years ending after publication and would also allow taxpayers to choose to apply the regulations, once finalized, before the applicability date.

Implications

Many taxpayers have historically relied on analogous authority to take a position that residence-based sourcing applied to borrow fees. Reluctant to rely on this authority, some withholding agents instead withheld tax on certain borrow fees paid to non-US persons. The new guidance therefore will generally be welcomed by taxpayers. The new guidance will also be welcomed by US counterparties, including US banks, that may believe they have been disadvantaged in the securities lending and sale-repurchase markets due to uncertainly around the withholding requirement. 

Although the guidance by its terms does not address the sourcing of borrow fees for assets other than securities (e.g., cryptocurrency), some advisors may take the view that the residence-based source rules issued under the Notice should also apply to these other fees as well.

Some financial institutions may use bespoke securities lending and/or sale-repurchase repo agreements in certain lines of business, especially with retail clients. Although these agreements may have provisions that generally correspond to the provisions in the industry-standard master agreements, they do not fit squarely within the scope of the Notice and therefore raise questions as to whether they are eligible for the Notice's sourcing rule. As parties to a securities loan or sale-repurchase transaction often modify certain terms of the industry-standard documentation, it is not clear how much deviation would cause the transaction to fail the Notice's requirement to include "standard market terms" in the documentation.