Alert September 30, 2008

IRS Issues Revenue Procedure on Securities Lending

The Internal Revenue Service (“IRS”) released Revenue Procedure 2008-63, which provides that when a securities loan is in default because the borrower (or an affiliate of the borrower) that is unrelated to the lender goes bankrupt, no gain or loss will be recognized if the lender applies the collateral to the purchase of identical securities as soon as practicable (and in any event within 30 days) after the default.  The IRS said in this case it would treat the purchase as an exchange to which Section 1058 applies, and the lender will receive the same nonrecognition treatment it would have received if the borrower had returned identical securities upon termination of the loan.  Prior to the issuance of the Revenue Procedure, it was generally believed that a default would result in recognition of gain (regardless of the reason for the default), and the IRS took that view in regulations that it proposed in 1983 that have not yet been finalized or withdrawn.  The Revenue Procedure changes that result in the case of a bankruptcy-related buy-in.  The Revenue Procedure is effective for tax years ending on or after January 1, 2008, but does not apply to securities lending defaults for reasons other than bankruptcy of the borrower or an affiliate or that are otherwise outside the scope of the Revenue Procedure.