On May 22, 2025, the House of Representatives passed by a one-vote margin the “One Big Beautiful Bill Act” (the “House Bill”), which has now moved to the Senate for consideration. This Memorandum discusses the House Bill’s proposed Section 899 of the Internal Revenue Code (the “Proposal”), which, if enacted in its current form, could result in significant changes to the taxation of inbound U.S. investment by foreign persons.

The Proposal is intended to retaliate against foreign taxes that the U.S. government views as unfairly targeting U.S. businesses. However, opponents of the Proposal have voiced concerns that it could lead to a global shift away from U.S. investment. While the Senate’s Majority Leader has indicated that Senate Republicans plan to study the Proposal’s potential impact, it remains to be seen what changes the Senate may make and whether it will significantly alter the Proposal. For a summary of the initial version of the House Bill, please see our Memorandum.

Overview

The Proposal would impose increased rates of U.S. taxation on foreign persons from “discriminatory foreign countries” (“DFCs”). A DFC is any foreign country having one or more “unfair foreign taxes,” which include a tax with an undertaxed profits rule (“UTPR”), a digital services tax, a diverted profits tax, and, to the extent provided by Treasury, other extraterritorial or discriminatory taxes. The Proposal also contains a catch-all category for any other tax enacted with a public or stated purpose indicating the tax will be economically borne, directly or indirectly, disproportionately by United States persons. 

An “extraterritorial tax” is generally a tax on a corporation that is determined by reference to income or profits received by a direct or indirect shareholder of such corporation. A “discriminatory tax” is a tax that: (i) applies more than incidentally to items of income that would not be considered from sources, or effectively connected to a trade or business, within the foreign country if such country were subject to U.S. tax rules; (ii) is imposed on a base other than net income and does not permit the recovery of costs and expenses; (iii) is exclusively or predominantly applicable, in practice or by its terms, to nonresident individuals and foreign corporations or partnerships or (iv) is not treated as an income tax by the foreign country laws or is otherwise outside the scope of income tax treaties in force between such foreign country and one or more other jurisdictions. 

The Proposal excludes from unfair foreign taxes any taxes that apply neither to a U.S. person (including a U.S. person’s trade or business) nor to a controlled foreign corporation (“CFC”) (including such CFC’s trade or business) more than 50% of which is owned by U.S. persons (by vote or value). In addition, certain taxes are excluded from the definitions of extraterritorial and discriminatory taxes, including:

• an income tax generally imposed on income of the foreign country’s citizens or residents, even if such income includes payments that would treated as foreign source income if U.S. tax rules applied;
• an income tax that would otherwise be an unfair foreign tax solely because it is imposed (i) on the income of nonresidents attributable to a trade or business in such foreign country or (ii) on the foreign country’s citizens or residents by reference to the income of a corporate subsidiary of such citizens or residents;
• a withholding or other gross basis tax on FDAP-type items sourced to the foreign country (other than a tax imposed on services performed by persons other than individuals);
• a value added tax, goods and services tax, sales tax or other similar consumption tax;
• a tax imposed with respect to transactions on a per-unit or per-transaction basis (rather than an ad valorem basis);
• a real or personal property tax, an estate tax, a gift tax or other similar tax; or
• a tax that would not otherwise be an extraterritorial or discriminatory tax except for the consolidation or loss sharing rules that apply only with respect to income of the foreign country’s tax residents.

Although undefined under the Proposal, we note that the UTPR, digital services taxes and diverted profits taxes would be deemed unfair foreign taxes automatically under the Proposal without formal designation by Treasury. The UTPR is an element of the OECD’s Pillar Two rules and has been adopted by a number of countries, including a majority of the European Union, Australia and the United Kingdom, and certain countries (including Canada, France, Italy, Spain, and the United Kingdom) have enacted digital services taxes.  However, the other categories of unfair foreign taxes would have to be designated by Treasury as such with respect to a foreign country before being treated as unfair foreign taxes, and the Proposal contemplates that Treasury will maintain a list of DFCs.

Foreign Investors Impacted

The Proposal would apply to the following broadly defined “applicable persons”:

• Foreign governments of a DFC;
• Individuals and foreign corporations that are tax residents of a DFC but excluding individuals who are U.S. citizens or residents and foreign corporations having U.S. direct or indirect ownership of 50% or more (by vote or value);
• Private foundations created or organized in a DFC;
• Non-public foreign corporations more than 50% owned (by vote or value) by applicable persons;
• Trusts where the majority of beneficial interests are held (directly or indirectly) by applicable persons; and
• Foreign partnerships and other entities identified with respect to a DFC by Treasury.

Taxes Subject to the Proposal

Very generally, foreign investors are subject to a 30% U.S. gross withholding tax on certain categories of passive U.S.-source income not connected with a U.S. trade or business (“FDAP income”)¹ and are subject to U.S. federal income tax on a net basis at regular U.S. income tax rates with respect to income treated as effectively connected with a U.S. trade or business (“ECI”), which includes gain from investment in U.S. real property pursuant to the “FIRPTA” rules.  A foreign corporation that incurs ECI may also be subject to an additional 30% branch profits tax, subject to reduction under a treaty.

Under the Proposal, applicable persons would be subject to increased U.S. federal income tax rates on FDAP income and ECI (limited to FIRPTA ECI in the case of individual applicable persons), the branch profits tax, the rate of tax imposed on U.S.-source gross investment income for foreign private foundations and the withholding taxes that apply with respect to FDAP income and FIRPTA ECI. In a case where an alternate rate applies in lieu of the statutory rate (e.g., a treaty rate), the increase would apply to such alternate rate, thereby overriding longstanding treaty arrangements. Neither the portfolio interest exemption nor the exemption from FIRPTA for qualified foreign pension funds appears to be at risk under the Proposal.   

Notably, foreign governments of a DFC would no longer be permitted to avail themselves of the Section 892 exemption under the Proposal.

The Proposal also modifies the base erosion and anti-abuse (“BEAT”) tax under Section 59A. In particular, a non-public foreign or U.S. corporation that is more than 50% owned (by vote or value) by applicable persons would be treated as subject to the BEAT tax without regard to whether it meets the $500 million gross receipts test or 3% base erosion percentage threshold and would be subject to a 12.5% (rather than 10%) BEAT tax rate. Other modifications nullify provisions of Section 59A that operate to mitigate the BEAT tax, including the provision that excludes a base erosion tax benefit attributable to a base erosion payment to which U.S. withholding tax applies, and treating certain favorable credits in the BEAT tax computation as zero. 

Increase in Tax Rates

The Proposal contemplates increases in rates by an “applicable number of percentage points,” which will generally be 5 percentage points for the 1-year period beginning on the “applicable date”² with an increase of 5 percentage points for subsequent 1-year periods. Increases are capped at the statutory rate plus 20 percentage points, but because the cap is keyed to the statutory rate, investors subject to alternate rates in lieu of the statutory rate could see increases that exceed 20 percentage points. For example, a foreign investor subject to Section 899 and eligible for a 15% treaty withholding rate on US-source dividend income would have a capped withholding rate of 50% (i.e., the 30% statutory rate plus 20 percentage points), which would be 35 percentage points above the rate that would otherwise apply. For a taxpayer that is an applicable person with respect to multiple DFCs, the highest applicable number of percentage points would apply.

The Proposal includes a safe harbor whereby the increase to withholding rates will not apply if the applicable DFC is not listed by Treasury as a DFC; provided that in the case of certain applicable persons (namely non-public foreign corporations more than 50% owned by applicable persons or trusts more than 50% beneficially owned by applicable persons) withholding will not apply if the applicable DFC (and such DFC’s applicable date) has been listed in such guidance for less than 90 days.

Relief from penalties and interest is generally provided for pre-2027 failures to withhold under the Proposal for withholding agents that can satisfactorily demonstrate that best efforts were made to comply with such withholding rules in a timely manner.

Years in Which the Proposal Would Apply 

With respect to the non-withholding taxes, the Proposal would apply to each taxable year beginning (i) after the later of (A) 90 days after Section 899’s enactment, (B) 180 days after enactment of the unfair foreign tax that triggers a country’s status as a DFC or (C) the first date that an unfair foreign tax of such country begins to apply; and (ii) before the last date on which the DFC imposes an unfair foreign tax. For withholding taxes, the Proposal would apply to each calendar year beginning during the period that such person is an applicable person. 

Guidance

The Proposal enables Treasury to issue regulatory or other guidance as “necessary or appropriate” to implement the Proposal’s purposes, including to:

• provide for necessary adjustments necessary to prevent avoidance, including the application of the Proposal to branches, partnerships and other entities;
• maintain (and update quarterly) a list of DCRs and their applicable dates (including notice to Congress of any changes to such list); and
• exercise authority to provide exceptions to “applicable persons” and additional exemptions from extraterritorial and discriminatory taxes.

Potential Impact on the Maritime Industry

Many shipping companies are established in countries that should not be considered DFCs, including, for instance, the Marshall Islands. Further, the Proposal does not appear to affect Code Sections 883 and 887. This may be due to the fact that the Pillar II rules generally provide a carve out for shipping. A privately-owned shipping company may be considered an applicable person to the extent it is incorporated in a DFC or its ownership causes it to be a DFC. If the private shipping company derives ECI, e.g., certain cruise and cargo liners, the Proposal could be impactful.

Takeaways

If enacted, new Section 899 could make inbound investment into the United States significantly less tax efficient.  This could have a substantial impact on the U.S. markets as the after-tax returns on U.S. investments by foreign investors could be materially reduced.

Given the scope of the Proposal, both sovereign and non-892 foreign investors could be impacted. For investment funds structured as partnerships, the effects of the Proposal would be felt at the partner level. Limited partners treated as applicable persons could be subject to increased taxation and withholding, and sovereign investors could lose their exemption under Section 892. 

For offshore funds that are corporations for U.S. federal income tax purposes, the Proposal may affect the fund itself if it is domiciled in a DFC or its ownership causes it to be an applicable person. Note that the Cayman Islands should not be viewed as having an unfair foreign tax, but other jurisdictions, for instance Ireland, where funds are domiciled do have or are adopting an unfair foreign tax and could be impacted by the Proposal. If an offshore fund is structured to be treaty-eligible, the structure should be reviewed to make sure it still works if the Proposal is enacted.  Certain treaty structures may have greater than 50%-United States ownership, which would mean the fund itself is not an “applicable person” subject to the Proposal.

United States real estate investment trusts that make distributions to applicable persons could also be impacted by the Proposal.

Short-term capital gains and interest dividends distributed by United States mutual funds (“RICs”) and business development companies (“BDCs”) should not be subject to the increased tax rates under the Proposal; however ordinary dividends would be.  Foreign source interest or gains distributed by a RIC or a BDC are also seemingly excluded from the Proposal.

Seward & Kissel LLP actively monitors tax changes and their impact on the investment management industry. For additional information, please contact a member of Seward & Kissel’s Tax Group.