In Chief Counsel Advice Memorandum 202548004 (memorandum), the IRS concluded that a partnership is not liable for withholding tax on borrow fees (including securities lending fees and negative rebates) that it receives and that are allocable to its foreign partners. The IRS based its conclusion on Notice 2025-63, which it concluded obsoleted an earlier July 2025 memorandum (the July memorandum was released to the public at the same time as this superseding one). An extension of the reasoning in the memorandum could allow taxpayers that have been subjected to withholding tax to claim refunds, as the IRS's position in this memorandum retroactively applies the sourcing rules, potentially resulting in the ability to claim refunds for taxes withheld in prior years.

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.

While some US-based financial institutions choose not to withhold on these payments to non-US persons, those that do withhold have argued that such withholding puts them at a disadvantage compared to their non-US-based competitors.

The July 2025 memorandum (202548005) concluded that a partnership's borrow fees are US-source income and that the partnership is liable for US tax not withheld from borrow fees allocable to the partnership's foreign partners.

In Notice 2025-63, the IRS announced that forthcoming proposed regulations would source borrow fees paid on securities lending and sale-repurchase transactions to the residence of the recipient. Fees determined to be non-US source under those regulations would not be subject to withholding under Chapters 3 and 4 (see Tax Alert 2025-2195). Notice 2025-63 allows taxpayers to rely on this sourcing rule for securities lending transactions and sale-repurchase transactions entered before the forthcoming proposed regulations are published.

Analysis

The memorandum concerns a taxpayer that is treated as a partnership for US tax purposes and is a hedge fund with foreign partners. According to the memorandum, an agent, on behalf of the taxpayer, executed thousands of sale and repurchase transactions (repo transactions) and reverse repo transactions.

The memorandum addresses two questions:

• Whether the taxpayer's repo transactions caused it to be engaged in a US trade or business (USTB) under IRC Section 882(a)
• If not engaged in a USTB, whether the borrow fees from these transactions were considered US-source FDAP income subject to tax and withholding under IRC Sections 871(a), 881(a), 1441 and 1442

The IRS first concluded that the taxpayer was not engaged in a USTB for the period in question, finding that the taxpayer was a non-dealer that generally engaged in exempt trading under the trading safe harbor, with any activity outside the safe harbor an investment activity ancillary to the safe harbor activity.

Regarding withholding, the IRS concluded that the taxpayer was not liable for withholding tax on the borrow fees. Although the borrow fees should be considered FDAP income, they met the criteria identified in Notice 2025-63, so the taxpayer may rely on that Notice to treat the borrow fees as foreign-source income to the extent allocable to the taxpayer's foreign partners. As foreign-source income, these fees were not subject to taxation under IRC Section 871(a) or 881.

Implications

The borrow fees discussed in the memorandum were incurred in 2020 and 2022. Because the borrow fees met the criteria identified in Notice 2025-63, the taxpayer could rely on that Notice to treat the securities lending fees as foreign-source income to the extent allocable to the taxpayer's foreign partners.

While taxpayers can rely on Notice 2025-63 until the proposed regulations are published, the IRS's reasoning in the memorandum permits taxpayers that have been subjected to withholding tax on borrow fees to claim refunds based on the retroactivity of the sourcing rules, which may allow recovery of taxes withheld in prior years.

The memorandum's conclusions on the effectively connected income issue (i.e., that the taxpayer's repo and reverse repo transactions did not cause the taxpayer to be treated as a dealer and were within the securities trading safe harbor) are welcome confirmation of the views generally held by many practitioners.