The IRS announced in Notice 2025-63 that it intends to issue proposed regulations that would set out a rule under which certain borrow fees paid with respect to securities lending transactions and sale-repurchase transactions would be sourced based on the residence of the recipient.
The IRS explained that the appropriate source rule for payments referred to as “borrow fees” or “negative rebate” (collectively, “borrow fees”) is uncertain, because neither the Code nor current regulations address it.
Borrow Fees in Securities Lending and Sale-Repurchase Transactions
In a securities lending transaction, one party lends securities to another party subject to an obligation by the securities borrower to return equivalent securities to the securities lender. The securities borrower typically transfers collateral to the securities lender in the form of cash, securities, or other financial instruments.
When the securities borrower posts non-cash collateral, the securities borrower pays the securities lender a “borrow fee.” When the securities borrower posts cash collateral, typical agreements provide for the securities lender to pay the securities borrower a “rebate” with respect to the cash collateral. Any excess return that the securities lender generates on the cash collateral over the rebate amount paid to the securities borrower is retained by the securities lender, providing it with the economic equivalent of a borrow fee. In certain circumstances, such as under low interest rates, the securities borrower in a cash-collateral transaction may pay to the securities lender an explicit fee, referred to as a “negative rebate.”
In a sale-repurchase (or “repo”) transaction, one party (the cash lender) purchases securities from another (the cash borrower) subject to an agreement for the cash borrower to repurchase equivalent securities in the future at a prearranged price. Such transactions may function economically as a secured loan of money, a securities lending transaction, or both.
When functioning as a securities lending transaction, the cash lender may require the cash borrower to sell and repurchase a specific security under a “special sale agreement.” The difference between the effective interest rate on the special sale agreement and the interest rate on a general collateral sale agreement economically functions as a borrow fee to the cash borrower. In addition, as in a securities lending transaction, a special sale-repurchase agreement may result in the cash lender paying a negative rebate when the interest rate for a general collateral sale-repurchase agreement is low or the demand for the specific security is high.
Planned Proposed Regulations
In forthcoming proposed regulations, the IRS plans to provide that the source of borrow fees paid with respect to a securities lending transaction or a sale-repurchase transaction is determined based on the residence of the recipient.
For this purpose, the notice defines a “borrow fee” (including negative rebate) as a fee that is:
(1) paid pursuant to a securities lending transaction or sale-repurchase transaction that is (i) documented on an industry-standard master agreement and confirmation (or electronic equivalent thereof) with standard market terms and (ii) entered into in the ordinary course of the taxpayer’s and counterparty’s trades or businesses or pursuant to their normal investment activities or objectives, and
(2) 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).
The notice further specifies that “securities lending transaction” and “sale-repurchase transaction” have the meanings provided in Reg. §§1.861-2(a)(7) and 1.861-3(a)(6).
The IRS states that the proposed regulations would apply prospectively to tax years ending after the regulations are published. Taxpayers may choose to apply the regulations, once finalized, before the applicability date, and taxpayers may rely on the rules described in Notice 2025-63 for transactions entered into before the forthcoming proposed regulations are published.
BDO Insights
The IRS’s announcement in Notice 2025-63 signals a shift in how borrow fees from securities lending and sale-repurchase transactions will be sourced for U.S. tax purposes. By tying the source of these payments to the recipient’s residence, the proposed regulations may have important implications for cross-border transactions and withholding tax obligations.
Taxpayers and financial institutions engaged in these transactions should consider the following:
- Review existing agreements: Ensure that master agreements and transaction documentation align with industry standards and contain sufficient detail to support compliance with the new sourcing rules.
- Assess reporting systems: Evaluate whether current systems can accurately identify and report the residency of recipients for borrow fee payments.
- Monitor regulatory developments: Stay informed about the progress of these proposed regulations and any related IRS guidance, as early adoption may be permitted.
- Consider treaty implications: Multinational groups should assess how the new sourcing rules may affect treaty benefits and withholding tax exposure.
BDO recommends proactive engagement with tax advisors to understand the potential impact of these changes and to prepare for compliance once the regulations are finalized.