Buried in the House version of the “One, Big, Beautiful Bill” there is a new Internal Revenue Code (IRC) Section 899 in which lawmakers and the current administration are considering enacting laws with punitive measures against foreign countries that impose unfair taxes targeting American businesses. This response would be implemented via two separate measures: increased withholding taxes on taxpayers from countries that levy “unfair” taxes, and changes to the tax rate and the definition of applicable taxpayers subject to the Base Erosion and Anti-Abuse Tax regime.
Currently, the House bill is being reviewed and marked up by the various Senate committees, and changes are expected. However, it is unknown whether Section 899 will be modified, removed, or kept as is. Given the potential magnitude of these changes, businesses with cross-border activity should be aware of these potential provisions.
Under the proposed bill, “unfair taxes” as defined in Section 899 include:
- Digital Services Taxes (DSTs)
- Undertaxed Profits Rules (UTPRs), which are part of the OECD’s Pillar 2 framework
- Diverted Profits Taxes
- Other taxes the Treasury designates as unfair or discriminatory
Tax Impact: Increased Applicable Tax Rates
If a country is labeled as imposing unfair taxes on U.S. taxpayers, Section 899 would raise U.S. tax rates on foreign taxpayers and governments from that country by 5 percentage points per year, up to a maximum increase of 20 percentage points. The additional withholding tax is expected to apply to FDAP (fixed, determinable, annual, and periodic) income, such as interest, dividends, royalties, and annuities, U.S. real estate investment income (FIRPTA) withholding taxes, and U.S. effectively connected income of foreign corporations, among others.
The affected taxpayers under this provision are (but not limited to):
- Foreign governments and their subsidiaries of any discriminatory foreign country;
- Any individual (other than a U.S. Citizen or resident) who is a tax resident of a discriminatory foreign country;
- Any foreign companies that are majority owned by persons who are tax residents in discriminatory foreign countries;
- Any private foundation created or organized in a discriminatory foreign country.
However, foreign companies (including Controlled Foreign Corporations and Partnerships) that are majority-owned by U.S. persons are generally unaffected.
Treaty Considerations and Statutory Exclusions
Even if a country has a tax treaty with the U.S. (which usually reduces tax rates), Section 899 is expected to apply. For example, a treaty-reduced rate of 10% could increase to 15% in year one, and then keep growing yearly by 5% up to 30% (10% treaty rate, plus a maximum of 20% under IRC 899).
However, income that is excluded by statute from taxation (such as that under the portfolio interest exemption) appears not to be affected by the new law and remains fully exempt from income (and withholding) taxes.
Tax Impact – Changes to BEAT (Base Erosion and Anti-Abuse Tax)
Section 899 would expand the application of BEAT to U.S. and foreign companies that are majority-owned by applicable (foreign) persons. The law proposed the following changes:
- Remove the $500 million gross receipts and 3% base erosion percentage in some cases;
- Expands what is considered “base erosion payments”;
- Disallow certain credits and exceptions;
- Apply higher BEAT rates (up to 12.5%) to U.S. companies owned by targeted foreign entities.
The result of the above proposed changes would be the subjection of smaller foreign-owned U.S. businesses and foreign corporations doing business in the U.S. to the BEAT provisions. The Base Erosion and Anti-Abuse Tax system was designed to prevent large multinational corporations from avoiding taxes by shifting profits out of the country through deductible payments to foreign affiliates. The application of BEAT to smaller businesses will add a significant administrative burden and costs, in addition to a potential increase in their tax liabilities.
While multiple proposed dates of applicability based on certain criteria exist, the earliest proposed date that would impact most taxpayers is January 1, 2026.
If enacted, these provisions would have a far-reaching impact on both U.S.-based and foreign-parented businesses, as well as foreign companies and individuals doing business in the U.S. Taxpayers who may be impacted by these provisions should start planning for the potential impact on their business and immediately contemplate any repatriation or restructuring considerations to minimize the future impact.
As mentioned above, the House bill is currently with the Senate for their consideration. As of this writing, it is unknown whether there will be any changes to the proposed Section 899, or if any parts of it will remain.
Should you have any questions or concerns, please contact your WG tax advisors for more information.
