Section 899: U.S. House Advances Legislation Targeting “Unfair Foreign Taxes”

Overview

Early on May 22, 2025, the United States House of Representatives narrowly passed the “One Big Beautiful Bill Act” (the “Bill”) that introduces a new Section 899 to the U.S. Internal Revenue Code (the “Code”), which could significantly increase tax rates applicable to certain non-U.S. individuals and business, governmental, and other entities connected to jurisdictions that impose “unfair foreign taxes” on U.S. individuals and business entities in such jurisdiction. The Bill would also expand the scope and applicable rate of the Base Erosion and Anti-Abuse Tax (“BEAT”), raising direct tax liabilities for non-U.S. controlled corporate groups.

The Bill will now advance to the United States Senate for its consideration, where significant changes to the Bill are still expected. If enacted in its current form, the provisions included in proposed Section 899 could affect a wide range of inbound investors, including non-U.S. governments, individuals, corporations,¹ private foundations, trusts, partnerships, and certain other entities (each, an “applicable person” for purposes of the Bill). 

Particularly noteworthy is how the proposal applies to non-U.S. governmental entities, which may lose the benefit of their Code Section 892 exemption² under U.S. tax law if their country is labeled as a “discriminatory foreign country.”

What constitutes a “Discriminatory Foreign Country” and “Unfair Foreign Taxes”?

The Bill introduces the concept of a “discriminatory foreign country,” which triggers additional tax burdens on applicable persons associated with such jurisdictions. According to the Bill, a “discriminatory foreign country” includes any non-U.S. jurisdiction that imposes one or more “unfair foreign taxes.”

The Bill identifies specific types of taxes, policies, and practices that qualify as “unfair foreign taxes.” These taxes are seen as discriminatory or extraterritorial in nature and are explicitly considered anti-competitive under U.S. tax policy. They include: (i) an undertaxed profits rule (“UTPR”), (ii) digital services tax, (iii) diverted profits tax, and (iv) to the extent provided by the U.S. Treasury, an “extraterritorial tax,” “discriminatory tax,” or any other tax enacted with a public or stated purpose that the tax be economically borne (directly or indirectly) disproportionately by U.S. persons.

Increased Tax Rates

Under the Bill, tax rates for applicable persons will rise incrementally based on a country's classification as a discriminatory foreign country. The increase depends on the “applicable number of percentage points,” starting at 5 percentage points and increasing by an additional 5 points each year that the jurisdiction maintains an unfair foreign tax. This incremental build-up is capped at a maximum increase of 20 percentage points above the statutory tax rate applicable to the relevant income item.

Taxes Affected by the Bill 

The Bill identifies several key taxes where applicable persons could face enhanced rates:

• Tax on U.S.-Source Non-Effectively Connected Income (“FDAP Income”)
  
  A 30% tax rate currently applies to FDAP Income, such as dividends, interest, rents, royalties, and certain other passive income from U.S. sources to the extent that the income is not “effectively connected income.” This tax is typically collected via withholding. 
• Tax on Effectively Connected Income (“ECI”)
  
  Nonresident individuals are taxed on their ECI at the graduated rates that apply to U.S. citizens and residents. Under the Bill, however, increased rates would only apply to nonresident individuals with respect to gains derived from the disposition of U.S. real property interests treated as ECI (i.e., “FIRPTA gains”). Other forms of ECI would remain subject to tax at the graduated rates otherwise applicable to U.S. individuals.
  
  Non-U.S. corporations are currently taxed at a flat rate of 21% on their ECI. This rate is equivalent to the standard corporate income tax rate imposed on domestic companies in the United States.
• Branch Profits Tax
  
  A 30% tax currently applies to the “dividend equivalent” amount of a non-U.S. corporation's profits attributable to branch operations in the United States (generally, the ECI earned by the non-U.S. corporation, including ECI earned through partnerships).
• Tax on Gain from the Disposition of U.S. Real Property Interests (“USRPIs”)
  
  Non-U.S. persons disposing of USRPIs are subject to unique tax and withholding rules that treat gains from the sale of USRPIs by non-U.S. persons as ECI (discussed above) and impose a 15% withholding tax on the total amount realized from the sale of USRPIs (to be withheld by the transferee).
• Tax on Gross U.S.-Source Investment Income of Non-U.S. Private Foundations
  
  Non-U.S. private foundations receiving U.S.-source investment income, such as interest, dividends, rents, royalties, or payments related to securities lending, are subject to a 4% tax (excluding “unrelated business taxable income”).

Interplay with Tax Treaties

Under Proposed Section 899, the provision is intended to override tax treaties to impose higher rates where those rates exceed the maximum allowed under an applicable treaty (as clarified in the Joint Committee on Taxation description of proposed Section 899).³ However, rate increases would use treaty-reduced rates as the baseline. For instance, if a treaty reduces the withholding tax on dividends to 5%, the increase will begin at 5% (rising to 10% in the first year), rather than at the standard 30% rate.

Uncertainty remains about whether treaty provisions that fully exempt certain income (e.g., interest, royalties, dividends) would continue to apply or if the treaty exemption would be treated as a “zero rate” baseline subject to the increase. It is also unclear the extent to which the Bill would be able to override treaty obligations as it is expected to be passed through the budget reconciliation process, which limits such legislation to fiscal matters (whereas treaty obligations generally also implicate the Senate foreign relations committee—which is not fiscal in nature). Further guidance from Treasury will be necessary to clarify these issues, especially for non-U.S. individuals and entities currently relying on beneficial treaty rates.

Expansion of the BEAT

The Bill broadens the scope of the BEAT, targeting more multinational corporate groups. In this respect, non-publicly held corporations that are majority-owned by applicable persons (directly and indirectly), including U.S. subsidiaries of certain non-U.S.-parented groups, could now fall within BEAT’s reach, even if they fail to meet the current gross receipts or base erosion percentage thresholds. Additionally, the BEAT rate applicable to such corporations would increase from 10% to 12.5%. Payments by such corporations to non-U.S. related parties, even if capitalized, would also be treated as “base erosion payments,” further expanding the tax’s scope.

Potential Implications for Non-U.S. Government Investors

Non-U.S. governments, including controlled entities of non-U.S. governments (e.g., sovereign wealth funds or state-run pension funds), also fall within the scope of Section 899. Those entities would be treated as “applicable persons,” meaning they, too, could lose preferential tax treatment notwithstanding the exemption otherwise available under Code Section 892 (which is a notable distinction from the text of the originally proposed Section 899, which did not include such an override of Code Section 892).

Under current U.S. tax law, Code Section 892 exempts non-U.S. governments from federal income tax on U.S.-source income from investments (e.g., dividends, interest, or earnings on U.S. real property holding corporations). The Bill would revoke this exemption for non-U.S. governments that qualify as “applicable persons.” This would significantly alter the tax burden faced by sovereign wealth funds and other state-controlled investment vehicles that are associated with a “discriminatory foreign country” when investing in the United States. As non-U.S. governmental investors are often key stakeholders in inbound transactions, the Bill could have a significant impact on the attractiveness of U.S. investments, particularly where such investors are not in a treaty jurisdiction.

Interplay with Other Exemptions from Income

The Bill does not appear to impact other exemptions on withholding or other taxes not explicitly addressed by the Bill, including (among others) the portfolio interest exemption under Code Sections 871(h) and 881(c) and the exemption from FIRPTA for “qualified foreign pension funds” under Code Section 897(l).

Timing Considerations

If enacted, Section 899 would take effect on January 1 of the calendar year following the latest of these events: 

• 90 days after Section 899 is enacted,
• 180 days after a non-U.S. jurisdiction enacts an “unfair foreign tax” (provided it occurs more than 90 days after Section 899 is enacted), or
• The date the “unfair foreign tax” first becomes effective (if that date is more than 180 days after the tax is enacted).

To support the transition, Section 899 includes safe harbor provisions for withholding agents through December 31, 2026. 

¹  Notably, the definition of an “applicable person” in the Bill includes any non-U.S. corporation that is a tax resident of a “discriminatory foreign country,” as well as any non-public non-U.S. corporation that is more than 50% owned (by vote or value) directly or indirectly by applicable persons. Under this definition, investment vehicles like offshore feeder funds could be classified as applicable persons if 50% or more of their equity is collectively owned by applicable persons from multiple countries, even if no single applicable person holds a 50% ownership stake. 

²  At a high level, Code Section 892 exempts non-U.S. governments from U.S. federal income tax on certain types of income, including passive investment income such as dividends, interest, and capital gains (including capital gains derived from an interest in a “United States real property holding corporation”), as well as interest on bank deposits. This exemption applies only to income earned through sovereign investment activities and does not extend to income earned from commercial activities.

³  Joint Committee on Taxation, Description of the Tax Provisions of the Chairman’s Amendment in the Nature of a Substitute to the Budget Reconciliation Legislative Recommendations Related to Tax (JCX-21-25), at 363, May 12, 2025.