House tax bill aims to counter unfair foreign taxes on U.S. investments

Authored by RSM US LLP

Executive summary

Republicans in the U.S. House of Representatives have proposed a new section of the tax code that would target inbound investment by individuals, entities and governments from countries that have in force any of the following:

• A digital service tax (DST)
• A Pillar II undertaxed profits rule (UTPR)
• A diverted profits tax (DPT)
• Similar extraterritorial or discriminatory taxes that Treasury determines is borne disproportionately by U.S. persons.

Enactment could have significant repercussions on inbound investment from impacted countries. U.S. investment funds would likely be compelled to consider structural adaptations for foreign investors in affected countries.

Republicans in the U.S. House of Representatives have proposed a new section of the tax code that would target inbound investment by individuals, entities and governments from countries that have in force any of the following:

• A digital service tax (DST)
• A Pillar II undertaxed profits rule (UTPR)
• A diverted profits tax (DPT)
• Similar extraterritorial or discriminatory taxes that Treasury determines is borne disproportionately by U.S. persons.

The proposed section 899—titled Enforcement of Remedies Against Unfair Foreign Taxes—would increase the rate of tax on FDAP (fixed, determinable, annual or periodical) income, ECI (effectively connected income), and the investment income tax on private foundations. The U.S. tax rate would increase by 5% every year the foreign tax is in effect, with a maximum increase of 20% above the statutory or treaty reduced tax rate.

Although the version of the draft legislation that the House Ways and Means Committee approved on May 14 would generally allow section 899 to override the lower rates in U.S. tax treaties, it is not clear whether the rate increase would also apply where the income is exempt under a treaty (e.g., where the treaty provides an exemption from ECI in the absence of a permanent establishment or provides an exemption for interest, dividends, or royalties).

The draft legislation would also prevent the section 892 exemption for investment income earned by foreign governments from applying to countries with these types of foreign taxes in effect. This may create an incentive for these governments (including sovereign wealth funds) to invest in other countries or to modify the nature of their U.S. investments to qualify for an alternative U.S. exemption (e.g., the section 881(c) portfolio interest exemption or the section 897(l) U.S. real property exemption for foreign pensions).

The draft legislation would also modify BEAT (base erosion and anti-abuse tax) for U.S. corporations that are more than 50% owned (directly or indirectly) by persons from these countries by treating the gross receipts and the base-eroding percentage tests as having been met. It would also eliminate the exceptions for deductible payments subject to full withholding and payments qualifying for the service cost method. This will likely cause BEAT to play a more significant role in tax considerations for U.S. corporations with affiliates from these countries.

Implications of the proposed section 899

The proposed section 899 is designed to put pressure on foreign countries to repeal these types of taxes. However, one can expect that not all impacted countries will respond immediately following enactment. The provisions may have significant repercussions on foreign investment from countries such as France, the United Kingdom, Germany, Japan, Canada, the Netherlands and India, which currently have a DST or UTPR in force.

Taxpayers that are resident in a treaty jurisdiction may challenge section 899 tax in court on the basis that it violates the nondiscrimination article in an applicable tax treaty. However, because the statute overrides existing treaty obligations, foreign countries that do not seek to repeal their DSTs or UTPRs may decide to terminate their treaty with the U.S.

If section 899 is enacted, U.S. investment funds may need to develop a new parallel structure for foreign investors from countries impacted by this provision and may want to consider forming holding structures in countries without these types of taxes to mitigate the impact.

With respect to ECI earned by individuals, the rate increase would only apply to ECI from the sale of U.S. real property interests. It would not apply to ECI from a U.S. trade or business. This may create an incentive for inbound investors from these countries to avoid using foreign blocker corporations to prevent an application of the higher rates on income from a U.S. trade or business.

Proposed section 899 would apply to tax years beginning 90 days after the date of enactment for taxpayers resident in countries with a UTPR, DST, or other “unfair foreign tax” in force on the date of enactment.

Countries with UTPRs in force as of April 2025

Countries with DSTs* in force as of April 2025

*This list does not include countries with digital permanent establishment rules, equalization levies (India), or more limited industry-specific digital taxes.

This article was written by Ramon Camacho, Aureon Herron-Hinds, Ayana Martinez, Lynn Dayan and originally appeared on 2025-05-21. Reprinted with permission from RSM US LLP.
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