I. Overview
Proposed Section 8991, introduced as part of the "Defending American Jobs and Investment Act" (H.R. 591) and incorporated into the House Ways and Means Committee's tax package titled "The One, Big, Beautiful Bill" (the "Bill"), aims to impose retaliatory tax measures against non-US countries deemed to levy discriminatory or extraterritorial taxes, such as digital services taxes (DSTs)2 or undertaxed profits rules (UTPR)3, that disproportionately affect US persons. The provision targets "applicable persons" from these "discriminatory foreign countries," including non-US governments, individuals, corporations, and certain entities, by increasing US federal income tax and withholding rates by up to 20 percentage points.
Proposed Section 899 also seeks to modify the current rules under the Base Erosion and Anti-Abuse Tax (BEAT) with respect to "applicable persons" from "discriminatory foreign countries." Under current law, US corporations with annual gross receipts of at least $500 million that make deductible payments to "foreign-related" parties are subject to a 10% minimum tax (known as BEAT). Section 899 proposes to (i) expand the scope of entities subject to BEAT to include certain US subsidiaries of non-US-parented groups, (ii) increase the applicable rate to 12.5% for such entities, (iii) reduce the benefits of certain credits for such entities, and (iv) expand the taxable base to include certain payments that are currently included, such as amounts taxed under Sections 871 or 881 and withheld under Sections 1441 or 1442 (i.e., fixed, determinable, annual, or periodical (FDAP) income).
II. Potential Impact on Section 892 and Tax Treaty Benefits
A significant impact of Section 899 is its proposal to deny Section 892 benefits for non-US governments of "discriminatory foreign countries." Section 892 generally exempts non-US governments and their controlled entities, such as sovereign wealth funds, from US federal income tax on income from investments in US stocks, bonds, and other securities, provided the income is not derived from commercial activities. Under proposed Section 899, these governments would lose this exemption, subjecting their US-source investment income to taxation. This marks a departure from prior versions of Section 899, which did not target Section 892 benefits, and this could significantly increase tax liabilities for affected sovereign wealth funds and other non-US government-controlled entities.
Regarding tax treaties, Section 899 could override certain preferential rates or exemptions provided under existing US income tax treaties. The Joint Committee on Taxation (JCT) report accompanying the Bill clarifies that the retaliatory tax may modify treaty-based reduced withholding rates or exemptions, potentially increasing taxes on FDAP income for applicable persons. Note, however, that it does not appear that proposed Section 899 applies to interest income exempt under the "portfolio interest exemption" rules. While tax treaties are designed to prevent double taxation and provide relief, the express authority in Section 899 to impose additional taxes "notwithstanding existing treaty obligations" raises concerns about treaty overrides, which could complicate international tax relations and impair treaty negotiations.
The Bill would be effective on the date of enactment. Once enacted, the proposed modifications under Section 899 would apply to tax years beginning after the later of (i) 90 days after the date of enactment of new Section 899, (ii) 180 days after the date of enactment of the unfair non-US tax that causes the country to be treated as a "discriminatory foreign country," and (iii) the first date that the country's unfair non-US tax begins to apply.
III. Final Thoughts
Proposed Section 899 introduces a robust mechanism to counter non-US tax regimes perceived as unfair, with significant implications for Section 892 benefits and tax treaty obligations. Although the negotiations of the Bill are just beginning and it is unclear whether Section 899 will be included in the final tax legislations in its proposed form, affected clients, particularly those with ties to non-US governments or jurisdictions with DSTs or UTPR, should prepare for potential increased US tax liabilities and monitor legislative developments closely, as the proposal's scope and treaty implications may evolve before enactment.
We will be monitoring Section 899 as the Bill progresses through Congress and will provide updates as further information becomes available.
Footnotes
1. Unless otherwise indicated, "Section" references are to the US Internal Revenue Code of 1986, as amended, and the Treasury Regulations promulgated thereunder.
2. DSTs are taxes imposed on the gross revenues of large digital companies operating in a specific jurisdiction. These taxes aim to capture revenue from digital businesses that may not have a significant physical presence in a country but still generate substantial income from users within its borders.
3. UTPR allows a country to increase taxes on a business if that business is part of a larger company that pays less than the proposed global minimum tax of 15% in another jurisdiction. This is part of the Organization for Economic Co-operation and Development's (OECD) Global Tax Deal under the Pillar 2 framework.
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