On Oct. 23, 2025, the IRS released Notice 2025-63 (the Notice), announcing that the Treasury and the IRS intend to issue proposed regulations addressing the sourcing of borrow fees, including negative rebates, paid in connection with securities lending transactions and sale-repurchase transactions (also known as repos). Under the proposed rules, these fees would be sourced based on the residence of the recipient, determined using the framework set forth in section 988(a)(3)(B).
The Notice resolves an issue that is not directly addressed by the Internal Revenue Code (sections 861 through 865) or by existing Treasury regulations. This gap in guidance created uncertainty, particularly when determining whether a borrow fee paid to a non-U.S. recipient was subject to gross-basis U.S. withholding tax at a rate of 30% under section 871(a) and section 881(a). Under prior practice, there was ambiguity as to whether such payments were U.S.-source income and, therefore, subject to withholding.
Under the approach described in the Notice, the source of borrow fees is determined by the residence of the recipient. If the recipient is a U.S. resident, the payment is U.S.-source income; if the recipient is a non-U.S. resident, the payment is foreign-source income. This sourcing rule is significant because under section 871(a) and section 881(a), only U.S.-source fixed or determinable annual or periodical (FDAP) income paid to nonresident aliens or foreign corporations is subject to U.S. gross-basis withholding tax. Therefore, under the Notice, borrow fees paid to non-U.S. residents will generally be foreign-source and not subject to U.S. withholding tax, unless otherwise treated as effectively connected income under general rules. The Notice does not alter the rules for effectively connected income, nor does it address documentation requirements for withholding.
Taxpayers may rely on the rules described in the Notice for transactions entered into before the proposed regulations are published. The regulations, once issued, are expected to apply prospectively to taxable years ending after the date of publication. Taxpayers may rely specifically on the rules described in section three of the Notice for transactions entered into before the proposed regulations are published.
Key definitions
Securities lending transaction
A securities lending transaction is an arrangement in which a lender temporarily transfers securities, such as stocks or bonds, to a borrower. The borrower provides collateral—typically cash or other securities—to secure the obligation to return equivalent securities at a later date. These transactions are governed by standardized master agreements, such as the Securities Industry and Financial Markets Association (SIFMA) Master Securities Loan Agreement, which set out the legal and commercial terms. For example, a pension fund may lend shares of a stock to a hedge fund. The hedge fund provides cash collateral and agrees to return the same number of shares after a specified period. The collateral is usually set at a value higher than the borrowed securities to protect the lender against market fluctuations. The borrower may use the borrowed securities to settle a short sale or fulfill delivery obligations.
Borrow fee
A borrow fee is a payment made by the borrower to the lender as compensation for the temporary use of the lender’s securities. This fee is typically paid when the borrower posts non-cash collateral, such as government bonds or other securities. For example, if a broker borrows shares from a mutual fund and posts government bonds as collateral, the broker pays a borrow fee to the mutual fund for the duration of the loan.
Rebate
A rebate is a payment made by the lender to the borrower when the borrower posts cash collateral. The lender invests the cash collateral and pays the borrower a rebate, which is a portion of the earnings generated from investing the cash collateral. The rebate is calculated daily and agreed upon by both parties. For example, if the lender earns 3% on the cash collateral and pays a 2% rebate to the borrower, the lender keeps the 1% difference.
Negative rebate
A negative rebate arises when the borrow fee exceeds the return the lender can earn on the cash collateral. In this situation, the borrower pays the lender an explicit fee equal to the excess of the borrow fee over the return on the cash collateral. This arrangement is common when interest rates are low or the securities being borrowed are in high demand. For example, if the borrow fee is 2% and the lender can only earn 1% on the cash collateral, the borrower pays the lender a negative rebate of 1%.
Sale-repurchase transaction (Repo)
A sale-repurchase transaction, or repo, is an agreement in which one party sells securities to another and simultaneously agrees to repurchase substantially identical securities at a future date for a prearranged price. Repos function as secured loans, with the securities serving as collateral for the cash provided. These transactions are also governed by standardized agreements, such as the Global Master Repurchase Agreement. For example, a dealer sells Treasury bonds to a money market fund and agrees to buy them back the next day at a slightly higher price. The difference between the sale and repurchase price reflects the interest earned by the money market fund.
Summary of the Notice
Notice 2025-63 states that the forthcoming regulations will source borrow fees, including negative rebates, paid in connection with securities lending transactions and sale-repurchase transactions (repos) according to the residence of the recipient. As a result, fees paid to non-U.S. persons, such as offshore hedge funds, generally will not be subject to U.S. withholding tax if the relevant documentation requirements are satisfied, unless the payment is otherwise treated as effectively connected income under general rules.
To be treated as foreign-source under the forthcoming regulations, a borrow fee must satisfy several substantive and procedural conditions, including the nature of the transaction, the governing documentation and the economic substance of the payment.
Transaction type
The fee must arise from a securities lending or repo transaction as defined under Treasury regulations. Specifically, covered transactions include those described in Reg. section 1.861-2(a)(7) (debt securities) and Reg. section 1.861-3(a)(6) (equity securities). A securities lending transaction is a transfer described in section 1058(a) or a substantially similar transaction. A sale-repurchase transaction (repo) is an agreement to transfer securities for cash and repurchase substantially identical securities in the future.
Documentation
The transaction must be governed by a standardized master agreement, such as the SIFMA Master Securities Loan Agreement or the Global Master Repurchase Agreement. These agreements reflect industry-standard legal and commercial terms and are widely used in the market.
Ordinary course of business
The transaction must occur in the ordinary course of the parties’ business or investment activity. The Notice is intended to apply to market-standard transactions, not bespoke or structured deals.
Fee substance
The payment must compensate the lender for making securities available, regardless of whether it is labeled as a ‘borrow fee’ or ‘negative rebate.’ The substance of the payment, rather than its label, determines whether it is covered.
Exclusions
The Notice excludes from its scope:
- Fees arising from non-standard or structured transactions that deviate from market norms or are not entered into under industry-standard agreements.Payments labeled as borrow fees that do not substantively compensate the lender for providing securities.
- Amounts paid in connection with one-off or customized transactions, or those lacking standard market business terms.
