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
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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: ------------------------------------
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from: ---------------------
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(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?

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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.

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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).

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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.

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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 ------------------------------------------------------
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------------------------------------------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 ----. --------------------------------------------------------------------------

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often phoned the counterparties.

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

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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.

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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

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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

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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.

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“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.

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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).

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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.).