Repo trading avoids U.S. business status and Notice 2025-63 prevents lending-fee withholding adjustment

Plain-English summary

This Chief Counsel Advice replaces an earlier memorandum about a foreign partnership hedge fund's repo and reverse-repo transactions. Chief Counsel again concluded that the fund was not a securities dealer and that its repo activity generally fell within the IRC § 864(b)(2)(A)(ii) safe harbor for trading in securities for its own account. Reverse repos used to invest excess cash were ancillary investment activity and did not create a U.S. trade or business. The updated advice changes the withholding conclusion because Notice 2025-63 permits qualifying securities-borrowing fees to be sourced by the recipient's residence. Because the transactions used industry-standard documents and arose in the parties' ordinary business or investment activities, fees allocable to the fund's foreign partners may be treated as foreign-source income. No adjustment should therefore be proposed for U.S. tax not withheld on those fees.

Ruling snapshot

• Question: Do the repo transactions create a U.S. trade or business, and must the fund withhold U.S. tax on securities-lending fees allocable to foreign partners?
• Outcome: Advice given: no U.S. trade or business and no withholding adjustment under Notice 2025-63
• Key authorities: IRC §§ 864(b)(2)(A)(ii), 871(a), 881(a), 882(a), 1441, 1442; Notice 2025-63

Full text (IRS public release)

       Office of Chief Counsel
       Internal Revenue Service
       memorandum
       Number: 202548004
       Release Date: 11/28/2025
       CC:INTL:B05: --------------                         Third Party Communication: None
       POSTU-117145-25                                     Date of Communication: Not Applicable

UILC: 881.00-00, 881.02-01, 871.00-00, 871.02-03, 864.01-00, 864.01-04

date: October 23, 2025

 to:   ------------------------------------
       ----------------------------------

       (-----------------------------------------)

from: ---------------------
-------------------------
------------------

       -----------------------
       -------------------------------------------------
       -------------------

       -----------------
       -------------------------------
       (International)

subject: Taxation of a Foreign Partnership Engaged in Repo Transactions

       This Chief Counsel Advice responds to your request for assistance. This advice may not be
       used or cited as precedent. This Chief Counsel Advice supplements and replaces our
       memorandum dated July 18, 2025, to reflect that subsequent guidance has obsoleted the
       section of that memorandum entitled “Taxpayer is Liable as a Withholding Agent for Gross
       Basis Tax on Certain U.S.-Source Lending Fees Allocable to its Non-U.S. Partners, II. Analysis.”
       For your convenience, this supplemented advice replaces the July 18, 2025, memorandum in its
       entirety.

       QUESTIONS PRESENTED

       Is a foreign taxpayer engaged in a trade or business within the United States for purposes of
       section 882(a) (“USTB”) because of its repo transactions (defined below) from which the
       taxpayer reported “interest” income for book purposes?

POSTU-117145-25 2

If the foreign taxpayer did not engage in a USTB, did the securities lending fees received by the
taxpayer in the repo transactions constitute fixed or determinable annual or periodic income
from U.S. sources that is subject to tax under sections 871(a) or 881(a) and withholding
thereof?

SHORT ANSWER

Under the facts presented, the taxpayer’s repo transactions are generally within a trading
safe harbor that prevents them from giving rise to a USTB and the reverse repo transactions
which may be outside of the trading safe harbor are merely investment activity ancillary to
the safe harbor transactions and insufficiently profit-oriented to give rise to a USTB.

Pursuant to Notice 2025-63 (released on October 23, 2025, available at
https://www.irs.gov/pub/irs-drop/n-25-63.pdf), no adjustment should be proposed for U.S. tax
not withheld on securities lending fees allocable to the taxpayer’s foreign partners.1

BACKGROUND

I. Commercial and Economic Background

In a sale and repurchase transaction (“repo transaction”), one counterparty (the “cash
lender” and “securities borrower”) purchases securities from another counterparty (the
“cash borrower” and “securities lender”) subject to an agreement for the cash borrower
(securities lender) to repurchase the securities in the future. Generally (and for purposes of
this memorandum), a “repo” is a repo transaction described from the perspective of the
cash borrower (securities lender), and a “reverse repo” is a repo transaction described
from the perspective of the cash lender (securities borrower).

   1 Reserved.

POSTU-117145-25 3

A repo transaction may function as a secured loan, a securities lending transaction, or both.
If the transaction is initiated because the initiating party wants to borrow money or put
money on hand to work, then the transaction resembles a loan. Repo transactions are often
collateralized by securities with a “value” equal to the loan “principal;” for this purpose,
however, the securities’ “value” is subject to a “haircut” (below fair market value), which
gives the cash lender some margin for price volatility. For example,2 a $9 million repo “loan”
subject to a1% effective interest rate and a 10% haircut would have the following
characteristics:

Where a repo transaction is intended primarily as a secured loan, the parties will often
agree to a “general collateral repo” (or “GC repo”). Under a GC repo, the cash borrower
(securities lender) elects how to secure the transaction from a basket of specified securities
that generally includes U.S. Treasuries. “Interest rates on overnight general collateral
R[epo]s on Treasury securities are usually quite close to rates on overnight loans in the
federal funds market. This reflects the essential character of a general collateral R[epo] as
a device for borrowing and lending money.”3

A repo transaction may also function as a securities lending transaction. If the securities
borrower (cash lender) insists on borrowing (purchasing and reselling) a specific security,
then the repo is described as “on special” or as a “special repo.” Generally, the effective
interest rate on a special repo is reduced below the interest rate on a GC repo (of equal
tenure) in an amount equal to the price of borrowing the specific security (such amount, the
“securities lending fee” or “borrow fee”). Thus, in the example above (interest rate of
1%), a securities lending fee of 0.7% would cause the interest rate to be 0.3%. The greater
the “specialness” of (demand for) a security, the greater the securities lending fee.

   2 This example is modeled after Figure 2 of Viktoria Baklanova, Adam Copeland & Rebecca

McCaughrin, Reference Guide to U.S. Repo and Securities Lending Markets 3 n.4, Fed. Res. Bank of
N.Y (“FRBNY”) Staff Report No. 740 (2015) (“FRBNY Reference Guide”).
3 Michael J. Fleming and Kenneth D. Garbade, Repurchase Agreements with Negative Interest

Rates,10(5) CURRENT ISSUES IN ECONOMICS AND FINANCE 2 (2004).

POSTU-117145-25 4

If the GC repo rate is already near 0% (as occurred between March 2020 and March 2022),4
then the securities lending fee can cause the special repo rate to drop below zero. For
example, suppose the price of a security is temporarily inflated or the security otherwise is
hard to borrow so that a securities borrower is willing to pay a securities lending fee of 1.5%
(to avoid a “fail to deliver” or to close out a short sale). If this securities lending transaction
is accomplished with a special repo that is executed under terms that are otherwise identical
to the repo illustrated above, then the effective interest rate on this special repo would be -
0.5%. In other words, the cash borrower will receive and report income on the special repo,
which some characterize as “negative rebate.” This transaction would appear as follows:

In this example, the cost of money is not negative. The cash lender/securities borrower is
willing to pay a market-rate securities lending fee greater than what it would have
demanded as market-rate compensation for the use or forbearance of money:

II. Facts

-----------------------------------------(“Macro Fund”) is a -----------------------------------------------------
------------------------------------------------------------------------------------------------------------ that is a
partnership for U.S. federal income tax purposes. Macro Fund is owned in part by ------------
------------------------(“Master Fund”), which is a partnership for U.S. federal income tax
purposes. Macro Fund and Master Fund (collectively, “Taxpayer”) are under examination
for tax year ending ---------------------------(the “Audit Year”). Unless otherwise stated, all
facts relate to the Audit Year and only the activities of Macro Fund discussed herein were

     4 FRBNY, Broad General Collateral Rate Data.

POSTU-117145-25 5

considered in making the USTB determination.

Master Fund is the master fund in one of several master-feeder investment vehicles created
by ----------------------------------------------(“Agent”).5 Agent, the investment manager of Master
Fund and Macro Fund, had complete discretion to trade on Taxpayer’s behalf.6 Agent
exercised that discretion through domestic and foreign personnel.7

      A. Trading and Financing Strategy

Agent markets Master Fund as a hedge fund engaged in typical hedge fund strategies. For
example, Agent engaged in what it described without elaboration as a “credit and macro” trading
strategy. Taxpayer did not provide further information about this strategy.

An organization chart provided by Taxpayer indicates that Macro Fund is the fund through
which Master Fund undertook what it termed its “macro strategies.” Master Fund owned
interests in several other funds that were domestic (U.S.) and foreign partnerships and
through which Master Fund undertook “------------------------------------.”

Taxpayer depended on large banks to finance its trading strategies. A ------- private
placement memorandum for one of the feeder funds that invested in Master Fund (the
“PPM”)8 notes that Master Fund was authorized to ------------------------------------------------------

------------------------------------------The PPM states that Taxpayer had no special access to
financing and instead relied on “-------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------”9 In this
regard, hedge funds typically rely on the handful of prime brokers that are also FRBNY
primary dealers, and Taxpayer apparently did the same.10 The PPM implies that Taxpayer
has limited bargaining power over its financing counterparties: while Taxpayer would “--------

------------------------------------------------.”11

Taxpayer did not market any strategy of loaning money or matched-book dealing. Agent,
however, established relationships with its trading counterparties (generally, large banks) and

      5 Agent is a ---------------------------------------.     United States citizen(s) indirectly control(s) 100% of

the general partner of Agent.
6 ----------------------------------------------------------------------------------------------------------------------------- --

----------------------------------------------------------------------------------------------------------------------------- ---------------

      7 On Agent’s website, it boasts “---------------------------------------------------------------------------------------

--------------------------------------------------------------------”
8 ----------------------------------------------------------------------------------------------------------------------------- --

----------------------------------------------------------------------------------------------------------------------------- ---------------

       9 PPM, at ----.
       10 See infra note 14 (noting that ----% of Taxpayer’s repo transactions were executed with FRBNY

primary dealers).
11 PPM, at ----. --------------------------------------------------------------------------

POSTU-117145-25 6

often phoned the counterparties.

Taxpayer asserts that it deposited inactive (excess) funds in highly liquid financial assets,
including by entering into reverse repos:

      --------------------------------------------------------------------------------------------------------
      --------------------------------------------------------------------------------------------------------
      --------------------------------------------------------------------------------------------------------
      --------------------------------------------------------------------------------------------------------
      --------------------------------------------------------------------------------------------------------
      ----------------

According to Taxpayer, the returns earned from depositing its inactive funds do not include any
embedded markup for services, unusual risk, etc. Taxpayer asserts that it was a price taker on
this activity and that it did not advertise itself as a cash lender.

      B. The Repo Transactions

During the Audit Year, Agent, on behalf of Taxpayer, executed thousands of repo and reverse
repo transactions.12 These transactions were with respect to government securities and
corporate debt.13 According to Taxpayer’s marketing materials, at least some of the repo
transactions were undertaken to “------------” other repo transactions; in other words, Taxpayer
would execute a repo to exit a position taken in an identical reverse repo, and vice versa.
Taxpayer undertook most of the repo transactions with large, generally domestic banks14 and
pursuant to master repurchase agreements, which permitted netting of offsetting payments.

Taxpayer executed the repo transactions after accepting an indicative (nonbinding) quote
posted to the ------------------------------------trading platforms. In the case of a special repo
transaction (described above), Taxpayer first made a request for a quote (“RFQ”) to the several
large banks with which Taxpayer maintained working relationships. Taxpayer made RFQs by
phone and electronically through a chat function on the trading platforms. Taxpayer represents
that it did not make quotes or respond to RFQs.

Taxpayer represents that nearly all the repo transactions permitted rehypothecation, and this is
consistent with how repo transactions are typically structured. It is not clear how often the
collateral was transferred to the cash lender (as opposed to held in the custody of the cash
borrower) or how often rehypothecation was exercised.

Most, if not all, of Taxpayer’s repo transactions were performed under standard “master
agreements” such as (i) the Global Master Repurchase Agreement (“GMRA”) published by

       12 Taxpayer’s books described a repo transaction as a “repo” where Taxpayer was the cash

lender (securities borrower), and as a “reverse repo” where Taxpayer was the cash borrower (securities
lender). This memorandum subscribes to the ordinary description of “repo” as a repo transaction from the
perspective of the cash borrower (securities lender).
13 Financial Statements for ---------------------------------------------------------------------------------------------

--------------------------------------------------------------------------------------------------- .
14 Approximately ----% of Taxpayer’s repo transactions were undertaken with ---- large banks.
Each of the large banks (or an affiliate thereof) is also listed on the current list of FRBNY primary
dealers.

POSTU-117145-25 7

International Capital Markets Association in collaboration with SIFMA, and (ii) the Global Master
Repurchase Agreement (“TBMA/ISMA”) published by the Bond Market Association and the
International Securities Market Association.

A sampling of Taxpayer’s repo transactions indicates that most had an overnight term or an
open term that is akin to an overnight term. A handful of the Taxpayer’s transactions had
unusually long terms: the sampling identified five reverse repos with an average term of 150
days. Most of the securities subject to the repo transactions were with respect to foreign
sovereign debt, and the remainder were with respect to U.S. Treasuries or corporate bonds.

   C. Book and Tax Reporting

Taxpayer’s books and records reflect considerable (and likely continuous) trading activity.
Taxpayer reported approximately: $--------------of purchased securities; $--------------of sold
securities; $--------------in proceeds from short sales; and $--------------in payments on short sales.
Taxpayer booked $---------------of interest income, including $---------------attributable to reverse
repos, and $--------------attributable to negative rebate, which Taxpayer described as “negative
interest expense.”

Each of Master Fund and Macro Fund filed a Form 1065 and concluded that it did not engage in
a USTB. Accordingly, each of Master Fund’s foreign partners filed a blank (protective) Form
1120-F. Neither Master Fund nor Macro Fund reported any withholding or gross basis tax on
securities lending fees, and neither filed a withholding tax return on either Forms 1042/1042-S
or Forms 8804/8805. Taxpayer has not claimed treaty benefits.

TAXPAYER IS NOT ENGAGED IN A USTB

   I.      Law

Section 882(a)(1) provides that a foreign corporation that is engaged in a USTB is taxable on a
net basis on its income that is effectively connected with the conduct of a USTB. Section 875(1)
provides that “a nonresident alien individual or foreign corporation shall be considered as being
engaged in a trade or business within the United States if the partnership of which such
individual or corporation is a member is so engaged.” The question at hand is whether
Taxpayer is engaged in a USTB.

           A. The Trading Safe Harbors

Congress enacted two statutory safe harbors (the “Trading Safe Harbors”) pursuant to which
certain trading activities conducted by or for a foreign person that might otherwise constitute a
USTB are treated as not being a USTB. The first Trading Safe Harbor (the “(A)(i) Safe Harbor”)
is not available to Taxpayer because it requires that the foreign person not conduct those
activities through an agent in the United States who has been granted discretionary authority or
through a U.S. office of the foreign person. § 864(b)(2)(A)(i) and (C).

The second Trading Safe Harbor (the “(A)(ii) Safe Harbor”) provides that the term “trade or
business within the United States” does not include “[t]rading in stocks or securities for the
taxpayer's own account, whether by the taxpayer or his employees or through a resident broker,
commission agent, custodian, or other agent, and whether or not any such employee or agent
has discretionary authority to make decisions in effecting the transactions.” § 864(b)(2)(A)(ii). A

POSTU-117145-25 8

dealer in stocks or securities may not use the (A)(ii) Safe Harbor. Id. The (A)(ii) Safe Harbor
may apply to a foreign person who has an office or other fixed place of business in the United
States.

           B. The Meaning of “Trading in Stocks or Securities” for Purposes of the
              Trading Safe Harbors

Both Trading Safe Harbors apply to “trading in stocks or securities.” The regulations under
section 864 interpret that term to mean “the effecting of transactions in stocks or securities,”
which includes “buying, selling (whether or not by entering into short sales), or trading in stocks,
securities, or contracts or options to buy or sell stocks or securities, on margin or otherwise …
and any other activity closely related thereto (such as obtaining credit for the purpose of
effectuating such buying, selling, or trading).” See Treas. Reg. § 1.864-2(c)(2)(i) and (ii)
(emphasis added). The volume of stock or security transactions effected during a taxable year is
irrelevant. See Treas. Reg. § 1.864-2(c)(1) and (2). For these purposes, the term “securities”
means any note, bond, debenture, or other evidence of indebtedness, or any evidence of an
interest in or right to subscribe to or purchase any of the foregoing. Treas. Reg. § 1.864-2(c)(2).

           C. The Meaning of “Dealer in Stocks or Securities” For Purposes of the
              (A)(ii) Safe Harbor

The regulations under section 864 define a “dealer in stocks or securities” as “a merchant of
stocks or securities, with an established place of business, regularly engaged as a merchant in
purchasing stocks or securities and selling them to customers with a view to the gains and
profits that may be derived therefrom.” Treas. Reg. § 1.864-2(c)(2)(iv)(a). A person that buys
and sells, or holds, stocks or securities solely for investment or speculation is not a dealer. Id.
A person's transactions in stocks or securities effected both in and outside the United States are
taken into account to determine whether the person is a dealer in stocks or securities. Id.
The regulations provide two exceptions to the definition of the term “dealer in stocks or
securities,” but they are not relevant to a person that is neither an underwriter nor acting as an
agent with respect to a customer that is not itself a dealer.

   II.     Analysis

Based on the facts described herein, we do not view Taxpayer as engaged in a USTB for the
period in question. Taxpayer is a non-dealer that generally engaged in exempt trading under the
(A)(ii) Safe Harbor. To the extent (if any) that Taxpayer’s reverse repo activity as described
herein is outside the safe harbor, the activity is an investment activity ancillary to the safe harbor
activity and does not give rise to a USTB.

                  A. Taxpayer is an Eligible Non-Dealer

Taxpayer was not a dealer in stocks or securities for purposes of the (A)(ii) Safe Harbor, even
though Taxpayer was “regularly engaged … in purchasing stocks or securities and selling them
to” others. See Treas. Reg. § 1.864-2(c)(2)(iv)(a). A dealer in the sense used in the (A)(ii) Safe
Harbor must be regularly engaged as a merchant with a view towards profiting from
“customers,” which is to say dealers seek to profit (even without a rise in value during the
interval of time between purchase and resale) “because they have or hope to find a market of
buyers who will purchase from them at a price in excess of their cost.” See Kemon v. Comm’r,
16 T.C. 1026, 1032 (1951) (defining property held primarily for the sale to “customers” under a

POSTU-117145-25 9

predecessor to section 1221(a)(1)). See also section 475(c)(1) (defining a dealer for purposes of
section 475 as a taxpayer who “regularly purchases securities from or sells securities to
customers in the ordinary course of a trade or business” or “regularly offers to enter into,
assume, offset, assign or otherwise terminate positions in securities with customers in the
ordinary course of a trade or business”). Taxpayer’s counterparties (generally large banks) were
“dealers” when they sought to profit from their superior access to the repo market, e.g., through
matched-book dealing. Taxpayer, by contrast, had less favorable access to the repo market
than its counterparties and could not expect to profit as a dealer. Instead, Taxpayer merely used
repo transactions to finance its trading and thereby profit from changes in the intrinsic value of
the underlying securities, e.g., “a rise in value during the interval of time
between purchase and resale ….” See Kemon, 16 T.C. at 1032.

The special repos require a separate analysis, because those transactions were not engaged in
by Taxpayer to borrow cash for trading purposes or to put excess cash on hand to work.
Special repos as conducted by the Taxpayer do not constitute a dealer activity. In Kemon v.
Commissioner, the court explained:

    Contrasted to “dealers” are those sellers of securities who perform no such
    merchandising functions and whose status as to the source of supply is not significantly
    different from that of those to whom they sell. That is, the securities are as easily
    accessible to one as the other and the seller performs no services that need be
    compensated for by a mark-up of the price of the securities he sells.15

Taxpayer offers to lend securities on special repo to the major banks that it deals with.
Presumably such major banks have other, and possibly better, ways to find securities they are
looking to borrow. Presumably, the banks would not be willing to pay Taxpayer a higher than
“normal” securities lending fee because it is easier to borrow these securities from Taxpayer
than to find those securities from another source. Thus, even though Taxpayer makes available
certain of its securities for loan to certain major banks with whom it normally transacts in its
trading strategy, that activity alone does not make Taxpayer a dealer in special repos as
described in Kemon.16 The facts available do not suggest that Taxpayer purchased securities
that did not otherwise fit its trading strategy merely so that they could be lent out at a profit on
special repo.

            B. Taxpayer Generally Engaged in Exempt Trading under the (A)(ii) Safe Harbor

Taxpayer’s extensive repo transactions do not give rise to a USTB because Taxpayer is eligible
for the “trading for own account” exclusion from a U.S. trade or business under Section
864(b)(2)(A)(ii) (the “(A)(ii) Safe Harbor”) and the repo transactions generally comprise the

         15 Kemon, 16 T.C. at 1033.


    16  We note that a dealer’s customers may be other dealers. In Estate of Hall v. Commissioner, a

partnership was a dealer in the securities of a particular corporation and “no one else was known in the
trade as a dealer in those securities.” 29 B.T.A. 1255, 1257 (1934), aff’d sub nom. Comm’r v. Stevens, 78
F.2d 713 (2d Cir. 1935). The partnership had “regular and repeated dealings with persons to whom it
sold” the stock; most of those purchasers were members of the New York Stock Exchange. Id. In
concluding that the partnership was a dealer, the court explained that the brokers who purchased the
stock were customers of the partnership under these particular facts. Id. at 1259. The facts here are
distinguishable, including that the major banks who transacted with Taxpayer had other sources of these
securities.

POSTU-117145-25 10

“buying, selling (whether or not by entering into short sales), or trading in stocks, securities, or
contracts or options to buy or sell stocks or securities, on margin or otherwise for the account
and risk of the taxpayer, and any other activity closely related thereto (such as obtaining credit
for the purpose of effectuating such buying, selling, or trading).” Treas. Reg. § 1.864-2(c)(2)(i)
and (ii).

                         1. Taxpayer’s repos and “special” repos

Taxpayer’s repo transactions in which Taxpayer “sold” securities and agreed to “repurchase”
them constitute the borrowing of money for tax purposes, which in substance is a pledge of the
securities transferred by Taxpayer.17 Obtaining credit for the purposes of trading in securities is
a permitted activity under the (A)(ii) Safe Harbor. Treas. Reg. § 1.864-2(c)(2)(i).

Because of the right to rehypothecate, a court may characterize the repo transactions for tax
purposes as securities lending transactions.18 The exchange of securities pursuant to a
securities lending transaction should qualify as the effecting of transactions in stocks or
securities and therefore also fit into the (A)(ii) Safe Harbor.19

                         2. Taxpayer’s reverse repos

Taxpayer engaged in reverse repos to borrow collateral for a short trade. Such transactions are
also considered effecting transactions in securities for purposes of the (A)(ii) Safe Harbor.

Taxpayer concedes that it undertook some reverse repos not solely as a way of borrowing
collateral for a short trade, but as a way of lending Taxpayer’s unused cash at the most
competitive rate. It is common knowledge that hedge funds that conduct trading and investment
activities are not always 100% invested in securities. Putting excess cash temporarily to work—
including by putting it out on repo if that is the best alternative on offer—can be an investment

    17 Rev. Rul. 74-27, 1974-1 C.B. 24.


    18 The Service and courts have found that a repo transaction was akin to a secured loan in

circumstances where the repo transaction did not permit rehypothecation of the collateral. E.g., Nebraska
Dept. of Revenue v. Loewenstein, 513 U.S. 123, 134 (1994) (“[I]n economic reality the [cash lender]
receive[s] interest on cash [it has] lent ….”); Rev. Rul. 74-27, 1974-1 C.B. 24 (1974). “One would be
comfortable, indeed extraordinarily comfortable, concluding that where the Purchaser/Lender cannot
dispose of or otherwise transfer repoed securities, the transaction is treated merely as a secured loan
based on the early cases.” Robert A. Rudnick & Kristen Garry, The Ultimate, Definitive Federal Income
Tax Treatment of Real Repo Transactions, 5 J. TAX’N FIN. PRODS. 49, 53 (2005). Repo transactions like
Taxpayer’s, which permit the securities borrower to dispose of the securities, may also involve a
securities lending transaction for tax purposes. Id. at 55 (“The grant of the power of disposition should be
analyzed as a transaction separate and apart from the lending of money and the provision of collateral,
which constitute the collateralized loan.”).
19 We note that the IRS has concluded that securities lending transactions involving publicly
traded securities and that meet the requirements of section 1058 constitute “effecting transactions in
stocks or securities” for purposes of Treas. Reg. § 1.864-2(c)(2). PLR 9041011 (Oct. 12, 1990); see
also Gen. Couns. Mem. 37313 (Nov. 7, 1977) (securities lending is not a trade or business for
unrelated business income tax purposes where the securities are not inventory in the lender’s
hands); cf. Temp. Treas. Reg. § 1.892-4T(c)(1) (lending securities is a permissible activity, rather
than the type of commercial activity that must not be engaged in, for a foreign sovereign relying upon
the Section 892 exclusion from income).

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activity ancillary to and consistent with the (A)(ii) Safe Harbor.

Furthermore, Taxpayer should not be viewed as engaged in the financing business of borrowing
money and lending it to its repo counterparties. Taxpayer was lending money (through
standardized reverse repos) to the same low-risk, large banks that were lending money to
Taxpayer (through repos and margin financing), and these banks (unlike Taxpayer) had access
to cheap financing through customer deposits and financing from the FRBNY. Courts have not
clearly defined the kind of “profit” that a taxpayer must intend to earn from a USTB, e.g., gross
profit, net profit, or something in between. Plainly, however, the taxpayer must intend to earn
income or gain in excess of the expenditures from the activity:20 to conclude otherwise would
contradict a long history of case law under sections 183, 162, and 165(a) that does not assume
a taxpayer has a “profit motive” from every gross-income-producing activity.21

It is highly unlikely that Taxpayer lending excess cash back to its banking creditors under these
circumstances could be expected to produce net profit as opposed to being the investment of
the excess cash. As in the case of the (A)(ii) Safe Harbor activity, this activity of Taxpayer also
was in the standardized repo market, and, in this context, Taxpayer was a price taker and
targeted a passive return on its funds.
Accordingly, for the reasons stated above, we conclude that Taxpayer’s activities described
herein do not cause it to be engaged in a USTB.

TAXPAYER IS NOT LIABLE AS A WITHHOLDING AGENT FOR GROSS BASIS
TAX ON CERTAIN LENDING FEES ALLOCABLE TO ITS NON-U.S. PARTNERS

           I.       Law

Generally, sections 871(a) and 881(a) impose a 30% tax on U.S.-source “fixed or determinable
annual or periodic gains, profits, and income” (“FDAP”) received by a nonresident alien
individual or a foreign corporation to the extent that the income is not effectively connected with
a USTB. Sections 1441 and 1442 require persons making payments of U.S.-source FDAP
income to foreign individuals and corporations to deduct and withhold this tax at source. FDAP
includes all gross income under section 61 other than gains from the sale of property and other
types of income as determined in published guidance. Treas. Reg. § 1.1441-2(b)(1) and (2).
The authority to exclude specified types of income from FDAP in guidance published in the
Internal Revenue Bulletin, Treas. Reg. § 1.1441-2(b)(2)(ii), has not been exercised.

Sections 871(a) and 881(a) impose tax on U.S.-source income only. The general rules for
determining the source of income are found in sections 861 through 865. The Code provides
specific sourcing rules for, among other items, interest, dividends, compensation for personal
services, rents and royalties, and income from sales of personal property. Generally, interest is
classified as U.S.-source when it is paid by the United States, a State or any political subdivision
of a State, or the District of Columbia. § 861(a)(1); Treas. Reg. § 1.861-2(a)(1). In addition,
interest on bonds, notes, or other interest-bearing obligations of noncorporate residents of the
United Stated or domestic corporations generally is classified as U.S.-source. § 861(a)(1);

    20 See Profit, BLACK'S LAW DICTIONARY (12th ed. 2024) (defining profit as “[t]he excess of revenues

over expenditures in a business transaction”).
21 See, e.g., Engdahl v. Comm’r, 72 T.C. 659, 664 (1979) (examining whether a horse breeding

activity was “not engaged in for profit” within the meaning of section 183(a) where the activity had
consistently earned “gross income” that fell short of applicable expenses).

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Treas. Reg. § 1.861- 2(a)(1). Other interest payments are generally classified as foreign-source.
§ 862(a)(1). Rental and royalty income is generally considered U.S.-source when those
payments are made in relation to property located in the United States or for the use of property
within the United States. §§ 861(a)(4) and 862(a)(4). Income from services performed in the
U.S. is U.S.-source. §§ 861(a)(3) and 862(a)(3).

Income from the sale of personal property other than inventory generally is U.S.-source when
sold by a U.S. resident and foreign-source when sold by a nonresident. § 865(a).22 One
exception to this rule is that if a nonresident maintains an office or fixed place of business (an
“Office”) in the United States, income from any sale of property attributable to that Office is
U.S.-source. § 865(e)(2). The principles of section 864(c)(5) apply to determine whether a
taxpayer has an Office and whether a sale is attributable to that Office. § 864(e)(3).

Section 865(j)(2) directs Treasury and IRS to promulgate regulations as may be necessary or
appropriate to carry out the purpose of section 865, including regulations applying the rules of
section 865 to income derived from trading in futures contracts, forward contracts, options
contracts, and other instruments.23 Treasury and IRS have not promulgated any rules under
section 865(j)(2).
Section 863(a) directs Treasury and IRS to promulgate sourcing rules for all items not subject to
any other statutory sourcing rule. However, Treasury and IRS have not promulgated rules for
the sourcing of securities lending fees. See T.D. 8735, 1997-2 C.B. 72, 73 (noting that the final
regulations addressing substitute interest payments and substitute dividend payments do not
address the treatment of fees in securities lending transactions).

“When an item of income is not classified within the confines of the statutory scheme nor by
regulation, courts have sourced the item by comparison and analogy with classes of income
specified within the statutes.” Bank of Am. v. United States, 680 F.2d 142, 147 (Ct. Cl. 1982)
(emphasis added); see also Container Corp. v. Comm’r, 134 T.C. 122, 131–32 (2010), aff’d per
curium without published opinion, 107 A.F.T.R. 2d 2011-1831 (5th Cir. 2011) (stating that “[i]f a
category of FDAP is not listed, caselaw tells us to proceed by analogy” and determining the
source of guaranty payments by analogy to the statutory sourcing rule for services and rejecting
the analogy to the statutory sourcing rule for interest); Howkins v. Comm’r, 49 T.C. 689, 693–94
(1968) (stating that the Code did not provide a specific source rule for alimony and explaining
that “the rules which are set forth [in sections 861–64] show, for the most part, that Congress
thought of the ‘source’ of an item of income in terms of the place where the income was
‘produced.’”); Rev. Rul. 2009-14, 2009-21 I.R.B. 1031 (explaining the source of income from the
payment of a death benefit is not specified in the Code and stating that sourcing of income in
such cases is determined by comparison with and analogy to classes of income that are
specified within the statute). “When we source FDAP income by analogy, our goal is to find the
‘source of income in terms of the business activities generating the income or ... the place
where the income was produced. Thus, the sourcing concept is concerned with the earning
point of income or, more specifically, identifying when and where profits are earned.’” Container
Corp., 134 T.C. at 136 (quoting Hunt v. Comm’r, 90 T.C. 1289, 1301 (1988)).

     22 In the case of sales made by a partnership, source is determined at the partner-level.   §

865(i)(5).
23 Congress did not provide additional guidance regarding regulations to be promulgated
under this provision. See S. Rep. 99-313, at 333, 1986-3 C.B. (Vol. 3) 333.

POSTU-117145-25 13

           II.    Analysis

In general, the negative rebate should be considered to give rise to FDAP. Because taxpayers
are permitted to rely on Notice 2025-63 (released on Oct. 23, 2025, available at
https://www.irs.gov/pub/irs-drop/n-25-63.pdf), Taxpayer may treat these fees as sourced
according to the residence of the recipient. Taxpayer, therefore, is not liable for withholding tax
under sections 1441 or 1442 on the securities lending fees (which are payable with respect to
the special repos24).

                  A. Source25

Notice 2025-63, Section 3 announced that the Secretary will issue proposed regulations to
address the source of certain borrow fees pursuant the Secretary’s rulemaking authority under
section 863(a). The proposed regulations will determine the source of certain borrow fees paid
with respect to securities lending transactions and sale-repurchase transactions based on the
residence of the recipient. Id. Notice 2025-63 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).” Id. Notice 2025-63 permits taxpayers to rely on the recipient residence source
rule it describes with respect to securities lending transactions and sale-repurchase transactions
entered into before proposed regulations are published in the Federal Register. Id. at Sec. 4.

Here, Taxpayer entered into these transactions on industry standard documentation. These
transactions were entered into in the ordinary course of Taxpayer’s investment activities or
objectives and its counterparties’ trades or businesses. The securities lending fees were paid to
compensate the Taxpayer for making its securities available to its counterparties. Because the
securities lending fees met the criteria identified in Notice 2025-63, Taxpayer may rely on that
Notice to treat the securities lending fees as foreign source income to the extent allocable to
Taxpayer’s foreign partners. As foreign source income, these fees are not subject to taxation
under section 871(a) or 881.

           B. Other Considerations

Taxpayer may be liable for gross-basis tax on some of the interest paid on the repos, but we
expect that most of the interest is exempt from tax. Interest on the repos is not FDAP to the
extent it is payable on an obligation with a term of 183 days or less. § 871(a)(1)(A) and (g)(1)(i);
see Treas. Reg. § 1.1273-1(c)(5). We understand Taxpayer’s repos generally have stated
terms of 183 days or less.

We understand some of the repos may be rolled over and not payable within 183 days of the
original issue of the obligation, but those repos are probably eligible for the portfolio interest

   24 Reserved.


   25 Footnotes 26 through 31 are omitted to conform the footnote numbering in this CCA to the

footnote numbering in the July 18, 2025, CAA (POSTU-115241-23).

POSTU-117145-25 14

exception if the repos are in registered form. See § 871(h). Repos executed under GMRA or
TBMA/ISMA should be viewed as in registered form because those agreements may not be
assigned or transferred without consent of the counterparty.32

If Taxpayer held any repos that do not directly meet the registration requirements, many of
those repos may be centrally cleared and treated as if they meet the registration requirements.
See Notice 2012-20; Notice 2006-99.

This writing may contain privileged information. Any unauthorized disclosure of this writing may
undermine our ability to protect the privileged information. If disclosure is determined to be
necessary, please contact this office for our views.

Please call (202) 317-6938 if you have any further questions.

    32 GMRA § 16(a); TBMA/ISMA § 13(a).       As to the concept of registered form for obligations not in

the form of “traditional” debt instruments, see DAVID GARLOCK ET AL., FEDERAL TAXATION OF DEBT
INSTRUMENTS, ¶ 1905.04[A] (2024 ed.).