Chief Counsel legal advice memo - Withholding tax implications of stock-lending transactions involving foreign investors 

Read the Chief Counsel legal advice memo* AM2012-009 [PDF 62 KB]

*IRS Chief Counsel legal advice memos are signed by executives in the IRS National Office of the Chief Counsel and issued to IRS personnel who are national program executives and managers. The legal advice memos are issued to assist IRS personnel in administering their programs by providing legal opinion on certain matters (such as industry-wide issues). They are not to be used or cited as precedent.

Overview

The IRS stated in the advice memo that it was aware of instances when financial institutions have promoted transactions structured as securities loans to allow foreign clients to claim that Notice 97-66 relieves them of U.S. withholding tax liability, even though no prior withholding taxes had been paid within a chain of transactions.

The issue presented in the advice memo was whether a securities borrower and a foreign securities lender would be liable for gross basis tax under the economic substance doctrine when the borrower and lender entered into a securities lending transaction in order to avoid withholding tax on U.S. source dividends (thus dividing the avoided tax between the borrower and the lender instead of remitting it to the U.S. Treasury).

The Chief Counsel advice memo concludes that, depending on the facts of the particular securities lending transaction, the IRS Commissioner may apply the economic substance doctrine to disregard such transactions.

Also, if a securities loan is structured along the lines of an example (as discussed in the advice memo) and is disregarded as lacking economic substance, then reliance on Notice 97-66 would be inappropriate. Accordingly:

• The nominal securities lender could be treated as having retained ownership of the loaned shares and as having received a U.S. source dividend subject to gross basis tax pursuant to section 871 or section 881.
• The nominal securities borrower could be treated as a U.S. withholding agent subject to liability for withholding tax pursuant to section 1441 or section 1442 and section 1461.