IRS Notice 2025-63: Source of Certain Borrow Fees

The IRS has released Notice 2025-63 stating their intent to issue regulations under section 863(a) of the Internal Revenue Code (the Code) which will clarify that the source of certain borrow fees and negative rebates (collectively “borrow fees”) paid with respect to securities lending transactions or sale-repurchase transactions shall be determined based on the residence of the recipient.

Securities Lending Transactions

A securities lending transaction occurs when one party loans securities to another in exchange for collateral: usually cash or other financial instruments. The borrower must return equivalent securities to the lender when the agreement ends. In cases where non-cash collateral is provided, the borrower will pay the lender an explicit borrow fee. If cash collateral is posted, the lender pays the borrower a rebate (return of collateral) and keeps any excess earnings on the collateral which is effectively a borrow fee. In certain cases, such as when demand for the loaned securities is high, the securities borrower would pay the lender an additional fee known as a negative rebate.

Sale-Repurchase Transactions

A sale-repurchase transaction (repo) is one where securities are purchased by one party known as the “cash lender” from a “cash borrower”. The cash borrower agrees to repurchase equivalent securities from the cash lender in the future at a prearranged price. 

A general collateral repo acts economically as a secured cash loan. This is a repo which involves unspecified high-quality assets (such as treasury securities), and in which the repurchase price includes a rate of return on the loan.

Repos may also function economically as securities lending transactions. Special repos (or specialized delivery repos) are ones in which the cash borrower is required to sell and repurchase a specific security. The effective interest rate on specialized delivery repos will generally be lower than the interest rate on general collateral repos (over the same term). The difference between these rates economically functions as a borrow fee to the cash borrower. Similar to a securities lending transaction, a specialized delivery repo in which demand for the specific security is high may result in the cash lender paying a negative rebate.

Proposed Regulations to be Issued

Currently, under sections 861 through 865 of the Code, specific sourcing rules can be found for, among other items, interest, dividends, rents, and royalties. Section 863(a) grants the Secretary of the Treasury authority to issue regulations for determining the allocation or apportionment of income not otherwise specified to sources within or without the United States.

Pursuant to this rulemaking authority, the following regulations would provide that the source of borrow fees paid with respect to securities lending transactions or sale-repurchase transactions be determined based on the residence of the recipient:

• A securities lending transaction and a sale-repurchase transaction would have the meanings provided under Treas. Reg. §§1.861-2(a)(7) (transactions with respect to debt securities) and 1.861-3(a)(6) (transactions with respect to equity securities).
• A borrow fee (including negative rebate) would be 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 residence of the recipient would be determined in the same manner as under section 988(a)(3)(B).

Applicability Date and Reliance

The proposed regulations would apply prospectively to taxable years ending after the regulations are published in the Federal Register. Taxpayers may also choose to apply the final regulations to tax years ending before the applicability date.

IRS Notice 2025-63 does not address the source of any other payments with respect to securities lending transactions, sale-repurchase transactions, or substantially similar transactions, including a payment described as a borrow fee that is not within the scope of this notice, such as an amount paid with respect to a one-off or structured transaction or a transaction that does not have standard market business terms.

Whether a fee labeled as a borrow fee is treated as such for Federal income tax purposes is determined by the substance on the fee, not the form.