New Section 899 – Enforcement of remedies against unfair taxes

Summary

On May 12, 2025, the House Ways & Means Committee released legislative text for a new code section 899 designed to impose retaliatory tax measures against unfair foreign taxes, including digital services taxes and the undertaxed profits rule (“UTPR”) currently adopted by over 25 members of the OECD as a part of its Pillar 2 global minimum tax regime.  Section 899 would increase US tax rates imposed on applicable tax residents of countries that have adopted such unfair taxes.  As described in more detail below, US tax rates could be increased for applicable tax residents of such countries, such as taxes imposed on effectively connected income, branch profits taxes, and taxes on fixed, determinable and periodic (“FDAP”) income, including withholding taxes on FDAP income.  In addition, as proposed, section 899 would significantly increase the scope of the base erosion and anti-abuse tax of section 59A (the “BEAT”) for applicable taxpayers and deny the exemption from US taxation provided for certain income of foreign governments if the governments adopt unfair foreign taxes.    However, some exemptions are provided for foreign applicable tax residents controlled by US persons.    

UTPR and digital services taxes

As described further below, section 899 applies to the UTPR, digital services taxes, and a variety of foreign taxes. The UTRP is one prong of the OECD’s Pillar 2 global minimum tax regime. Pillar 2 seeks to impose a minimum 15% corporate tax rate on in-scope multinational enterprise (“MNE”) groups with annual consolidated revenue of at least €750m. Over 25 countries have implemented the UTPR, including Australia, most European Union countries, and the UK. Under the UTPR, corporations tax resident in such countries could impose the global minimum tax of 15% on certain indirect affiliates, provided that no other corporation that has an actual direct or indirect ownership interest in such affiliate collects such tax under a domestic top-up tax or pursuant to the income inclusion rule (“IIR”) of Pillar 2. In other words, the profits of a U.S. entity within an MNE group could become subject to tax in a foreign country that has adopted the UTPR solely by virtue of the U.S. entity’s affiliation with another MNE group member located in such foreign country, even though the affiliate does not itself directly or indirectly through subsidiaries own an interest in such U.S. entity.

Section 899 was also targeted at various digital services taxes. Various countries have adopted digital services taxes as a way to collect tax on digital services provided to users located in the country, even if the entity providing the services lacks a physical presence in their country.   

Overview of Section 899 and unfair foreign taxes

Generally, under proposed section 899, certain nonresident taxpayers connected to foreign countries that impose an “unfair foreign tax” are subject to increased US tax rates on certain categories of income. 

For purposes of section 899, the term “unfair foreign tax” includes a UTPR, digital services tax, and, to the extent provided by the Secretary, an “extraterritorial tax,” “discriminatory tax,” or other taxes “enacted with a public or stated purpose indicating the tax will be economically borne, directly or indirectly, disproportionately by United States persons.” Aimed at taxes imposed under the Pillar 2 framework that allows a jurisdiction to tax an entity based on the MNE group’s global profits, the term “extraterritorial tax” refers to taxes on a corporation that are determined by reference to the income of a direct or indirect shareholder of the corporation. The term “discriminatory tax” is broadly defined to include a tax imposed by a foreign country if (a) such tax applies “more than incidentally” to items of income that would not be considered to be from sources, or effectively connected to a trade or business, within the foreign country if the sourcing and effectively-connected rules of the United States were applied by treating such foreign country as though it were the United States; (b) such tax is imposed on a gross basis (i.e., does not permit the recovery of costs); (c) such tax is “exclusively or predominantly” applicable, in practice or by its terms, to nonresident individuals and foreign corporations or partnerships; or (d) such tax is not treated as an income tax by such foreign country or is treated by such country as outside of the scope of any income tax treaties between the foreign country and other jurisdictions. 

Certain more-traditional taxes that may affect nonresidents are excluded from the definitions of “extraterritorial tax” and “discriminatory tax.” For example, (a) an income tax that is generally imposed on the income of citizens or residents of the foreign country even if income that would be foreign source income as determined under US rules is taxed, (b) an income tax of a foreign country that is imposed (i) on the income of nonresidents that is attributable to activity in such foreign country or (ii) on citizens or residents of such foreign country by reference to the income of a corporate subsidiary of such citizens or residents, (c) a foreign country’s withholding tax on FDAP income sourced to the foreign country, and (d) a value added tax, sales tax, or other similar consumption tax are each excluded. 

Accordingly, the broad definition of “unfair foreign tax” targets not only UTPRs and digital services taxes but allows the Secretary to identify other taxes on an ongoing basis that may be considered discriminatory or extraterritorial. 

Applicable non-resident taxpayers

Only non-resident taxpayers that have a sufficient connection to a “discriminatory foreign country” (i.e., a country that has one or more unfair foreign taxes) are subject to the increased tax rates of section 899. The term “applicable person” is used to identify such taxpayers and includes (1) a government of any discriminatory foreign country, (2) an individual (other than a citizen or resident of the US) who is a tax resident of a discriminatory foreign country, (3) any foreign corporation that is a tax resident of a discriminatory foreign country other than a US-owned foreign corporation (as defined in section 904(h)(6), which generally requires US persons to own 50 percent or more of the total combined voting power or value of the stock of such foreign corporation), (5) any privately-held foreign corporation if more than 50 percent of the total voting power or value of the stock is owned (within the meaning of section 958(a), which treats stock owned indirectly through a foreign entity as owned proportionally by the foreign entity’s shareholders, partners, or beneficiaries) by applicable persons, and (6) foreign partnerships, branches, and other entities identified with respect to a discriminatory foreign country by the Secretary. The expansive definition of applicable person provided for purposes of section 899 will require diligence from taxpayers to determine whether they are subject to the section. 

Increased rates and applicable date

Section 899 generally provides for an annual 5 percent increase in the tax rates of applicable persons. With respect to any discriminatory foreign country, the tax rates for an applicable person are increased by 5 percentage points for the 1-year period beginning on the “applicable date” and an additional 5 percentage points for each annual anniversary of such date. The rate increase applies after the application of an applicable income tax treaty. Thus, for example, if an applicable taxpayer were otherwise eligible for a 10% rate on US source dividends pursuant to an income tax treaty between the taxpayer’s country of residency and the United States, the initial 5% increase would be added to the 10% rate and would then be adjusted upward for each subsequent year. The interaction of section 899 with income tax treaties is distinct from legislation previously introduced by Ways and Means Committee Chair Jason Smith (R-Mo.), which would have disregarded treaty benefits entirely. 

The term “applicable date” means, for any discriminatory foreign country, the first day of the first calendar year beginning on or after the latest of (1) 90 days after the enactment of section 899, (2) 180 days after the enactment of the unfair foreign tax that causes such country to be treated as a discriminatory foreign country, or (3) the first date that an unfair foreign tax of such country begins to apply. Tax rates cannot increase to a rate that exceeds the statutory rate (determined without regard to any rate applicable in lieu of such statutory rate) plus 20 percentage points. For example, in the case of withholding taxes on US source FDAP income, the tax rate imposed under section 899 could not exceed 50% (i.e., the statutory rate of 30% plus 20 percentage points).  Additionally, if a taxpayer is an applicable person with respect to more than one discriminatory foreign country, the highest potential increase among such countries shall apply.

The types of taxes subject to increased rates include taxes on FDAP income (including withholding taxes on such income), taxes on income effectively connected with the conduct of a trade or business within the US, branch profits tax, and taxes on the disposition of a United States real property interest (as defined by section 897(c)). 

For withholding taxes, a safe harbor eliminates the increases to tax rates described above if the discriminatory foreign country with respect to which a taxpayer is an applicable person is not listed in the Secretary’s guidance either at all or for a sufficient period of time (depending on the type of taxpayer).

Covered taxes

In addition to the increased rate structure, section 899 modifies certain other US tax rules to disapply benefits otherwise allowed to applicable persons. Under proposed section 899, applicable persons are no longer eligible for the exemption from US tax for the income of foreign governments under section 892(a). Additionally, the BEAT is modified to remove the gross receipts threshold and base erosion percentage requirements that must otherwise be met before taxpayers are subject to the BEAT.  Whereas the BEAT currently applies to relatively few foreign-parented MNEs currently because the BEAT generally requires a taxpayer to have average annual gross receipts of $500,000,000, the BEAT will effectively apply to all tax residents of countries with discriminatory foreign taxes because this threshold will be removed.

Regulations

Section 899 includes authority for the Secretary to issue guidance as may be “necessary or appropriate” to carry out the section’s purposes. This authority includes authority for adjustments regarding the application of this section with respect to branches, partnerships, and other entities. As section 899’s rules with respect to pass-through entities such as branches and partnerships are largely undefined, such guidance will be critical for guiding taxpayers. As referenced above, section 899(e) also instructs the Secretary to list each discriminatory foreign country and their applicable date and to update such guidance on a quarterly basis.

Key takeaways

Given the potentially dramatic consequences, taxpayers will want to confirm their status as applicable persons and will need to monitor the Secretary’s listing of discriminatory foreign countries regularly. Diligent review, including of an entity’s ultimate owners, may be needed to identify whether a foreign person is subject to section 899, and a taxpayer may need to compile documentation to demonstrate an exemption from section 899 to withholding agents. Foreign entities may also be more restrictive about who may own their equity given the tax residency of an entity’s shareholders or partners may significantly impact the US tax rates paid by the entity.  Where flexibility exists, allowing US persons in a joint venture with non-US persons to control an entity that is a foreign applicable tax resident may help to limit the impact of section 899. 

Authored by Jay Singer, Elizabeth Adams, and Max Feinstein.