Among the myriad provisions of the budget bill that passed the U.S. House of Representatives last month, one that has recently gained increased prominence in recent weeks is proposed Section 899, increasingly referred to as the "revenge tax." This provision, a form of which was also included in the draft legislative text released by the Senate Finance Committee on June 16, imposes increased tax rates on residents of jurisdictions imposing so-called "unfair foreign taxes" ("UFTs") on U.S. taxpayers and their subsidiaries. While most of the changes in the Senate's draft moderate or clarify exemptions to the provisions contained in the House's draft, it also contains language that would grant the president discretion to double taxes on corporations and citizens of countries imposing UFTs.
Section 899 applies to "applicable persons," defined as the governments and corporate and individual residents of countries imposing UFTs. Additionally, private foundations organized within countries imposing UFTs would be applicable persons, as would corporations and trusts (regardless of residence) owned by applicable persons.
Under both bills, the taxes deemed "unfair" include digital services taxes, undertaxed profits, rules ("UTPRs"), and any other taxes determined to be "discriminatory" or "extraterritorial" under broad criteria set forth in the statute. (The House version of Section 899 would also include "diverted profits taxes"; while those are not per se UFTs under the Senate's version, it is possible that some of these taxes might nonetheless be treated as "discriminatory" or "extraterritorial.")
Additionally, the Senate's version of the bill distinguishes between "discriminatory" UFTs (including digital services taxes, certain non-income taxes and taxes that apply exclusively or predominantly to nonresidents) and "extraterritorial" UFTs (such as UTPRs and other taxes that are determined by reference to related persons, rather than by reason of direct or indirect ownership). The most severe consequences appear reserved for applicable persons in jurisdictions that impose extraterritorial taxes.
Section 899 would increase the rate of taxes imposed on applicable persons (under the Senate's draft, applicable persons in jurisdictions that impose extraterritorial UFTs) by five percentage points for each year that their jurisdiction of residence imposes a UFT, up to a specified maximum increase (20 percentage points over the statutory rate under the House's draft, 15 under the Senate's). In particular, Section 899 would increase the rate of the following existing taxes:
- tax on income effectively connected with the conduct of a S. trade or business and gain from dispositions of U.S. real property interests (currently 21% for corporations and up to 35% for individuals);
- branch profits tax (currently 30%);
- foreign private foundation excise tax (currently 4%);
- withholding tax on FDAP payments such as interest, dividends, and royalties (currently 30%); and
- withholding tax on proceeds of U.S. property sales (currently 15%)
Under the House's draft, these increased rates would first be levied in calendar years beginning on the later of 90 days after the bill's enactment, 180 days after a country's enactment of a UFT or the first date that a country levies a UFT. The Senate's draft, by contrast, extends the effective date of Section 899 to one year after Section 899 is enacted. Notably, under the Senate's draft, both the tax rate increases associated with extraterritorial taxes and their effective dates apparently would be calculated retroactive to any earlier date on which a discriminatory tax was first imposed.
In addition, under both drafts, Section 899 would impose a more restrictive version of the Base Erosion Anti-Abuse Tax (BEAT) to U.S. corporations owned by applicable persons.
It also appears that Section 899 would increase the tax rates imposed on applicable persons that are otherwise eligible for the benefits of an income tax treaty with the U.S. Under the House's draft, this increase would appear to continue escalating up to 20 percentage points above the statutory rate (rather than the reduced treaty rate). By contrast, under the Senate's version of Section 899, it appears that the increase would top out at 15 percentage points above the treaty rate. Some commentators have suggested, however, that the text of Section 899 (neither version of which expressly mentions tax treaties) may not be sufficiently explicit to override the reduced rate prescribed by tax treaties. (It has been speculated that the bill's drafters may have omitted an explicit override provision in order to qualify under the Senate's budget reconciliation rules.)
Both drafts of Section 899 would also repeal the exemption granted to foreign governments on income from U.S. investments and bank interest for governments of countries imposing UFTs. In some cases, these governments may be able to fall back on reduced rates under a tax treaty with the U.S., although as discussed above, these rates may themselves be subject to increase.
While the House's draft was unclear how the statutory rate increases would apply in cases where income is exempt from tax, the Senate draft confirms that a number of specific exemptions from tax, including the withholding tax exemptions for portfolio interest, bank deposits and "interest-related dividends" paid by regulated investment companies, would remain untouched. The Senate draft also confirms, however, that other exemptions from tax will be treated as a "zero" rate of tax that is subject to incrementation. It is unclear how broadly this extends—while it seems likely that this is intended to capture provisions of tax treaties such as those exempting interest from withholding tax, it would also seem to apply equally to provisions exempting business profits not attributable to a permanent establishment, and potentially even to foreign charities recognized as tax-exempt under Section 501(c)(3).
Lastly, the Senate's draft amends Section 891, a longstanding retaliatory tax regime that has never been invoked in practice. Enacted in 1934, Section 891 allows the president to double the rate of tax imposed on citizens and corporations of foreign countries that the president proclaims are subjecting U.S. citizens and corporations to "discriminatory or extraterritorial" taxes. The Senate's bill would provide that "discriminatory" and "extraterritorial" would have the same meaning as provided in Section 899. While in some ways Section 891 appears more limited than proposed Section 899 (for example, requiring a specific presidential proclamation before it goes into effect), it applies not only to nonresidents but also to U.S. residents, such as green card holders. Earlier this year, the president issued a memorandum calling for the Treasury to determine whether digital service taxes and similar measures could be invoked to trigger the use of Section 891.
Section 899 must still pass the Senate before becoming law, and it remains unclear what form it will take if it does. While the provision garnered little attention before it passed the House, it has subsequently drawn considerable focus in both the specialized tax press and the broader business and political media, as well as among business and finance leaders both domestically and abroad. The Senate draft's express exemption of portfolio interest from increased rates may allay some of the most apocalyptic fears that have been voiced regarding the effect of Section 899. If enacted, however, the law could nevertheless significantly deter both foreign direct investment in the U.S. and foreign portfolio investments in U.S. equities. Section 899's defenders in Congress and the Trump administration insist that the provision is unlikely to ever be enforced, as its existence will compel countries imposing UFTs to repeal those taxes or enact exemptions for U.S. companies. Unless (and until) that happens, however, the uncertainty associated with the possibility of this law may nevertheless have a similar deterrent effect on U.S. investment.
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