Implications of section 899 for withholding agents and investors

This article, originally published the morning of June 26, has been updated to reflect that Republican congressional leaders in the evening of June 26 announced they would remove the section 899 proposal from the broad taxation-and-spending package after the secretary of the U.S. Department of the Treasury announced a tax agreement with G7 countries.   

Executive summary: Effects of proposed section 899 on withholding agents and investors

Congress is considering a new section of the Internal Revenue Code, section 899, that would have significant implications for global companies and their investors. If section 899 were enacted, withholding agents would face increased compliance obligations and more detailed record-keeping requirements. They would also have to implement new systems and procedures for monitoring the status of offending countries.

They may also need to reevaluate their structures and investment strategies, and they may be subject to increased penalties and interest for under-withholding on payees from offending countries. Likewise, foreign investors may be subject to higher rates of withholding, may need to provide additional documentation to support tax rates applied, and may opt to reevaluate their investment strategies.

However, Republican congressional leaders on June 26 announced they would remove the section 899 proposal from the broad taxation-and-spending package after the secretary of the U.S. Department of the Treasury announced a tax agreement with G7 countries.

Proposed new section 899

On June 16, 2025, the U.S. Senate Finance Committee published its initial draft of the Defending American Jobs and Investment Act (the bill) for inclusion in the One Big Beautiful Bill Act (H.R. 1), modifying various provisions of the legislation passed by the House of Representatives on May 22, 2025.

The Senate version of the bill retains newly introduced section 899, the provisions of which broadly follow the House provisions. The Senate introduced some modifications to impose an additional retaliatory income tax on residents of countries that impose unfair taxes on U.S. persons.

Most significantly, the Senate has proposed to lower the maximum rate of the withholding tax increase from 20%, as proposed by the House, to 15%. The Senate also proposed delaying the effective date of the rules by slightly more than one year, from Oct. 1, 2025, to an effective date of Jan. 1, 2027. That delay would be welcomed relief for taxpayers, but it still may not be enough to alleviate the potential impact for global companies and their investors.

Enactment could also have significant repercussions for inbound investment from impacted countries. As such, companies may be inclined to reevaluate their investment strategies and to modify their structures, taking the additional tax into account. 

Under both the House and Senate versions of the bill, section 899 targets “applicable persons” from countries that impose allegedly “unfair taxes” on U.S. citizens and companies by increasing the withholding tax rate on certain income paid to residents of these offending foreign countries.

The increased rates under section 899 start at 5% the first year, increasing 5% each year after that on the anniversary date of the original imposition of the 5% rate, with a maximum increase of 15% under the Senate bill (as opposed to a 20% maximum rate increase proposed under the House bill).

The Senate bill would:

• Increase the U.S. federal income tax withholding rate on fixed, determinable, annual and periodical (FDAP) income derived from U.S. sources that is paid to non-U.S. persons that are residents of offending countries that have adopted extraterritorial taxes by 5% per year up to a 15% maximum increase (as opposed to a 20% increase proposed in the House bill), unless and until the jurisdiction eliminates the extraterritorial tax or revises it so as not to apply to U.S. persons and their foreign subsidiaries.
• Increase taxes on governments of offending foreign countries by rendering inapplicable the exemption under section 892(a)(1) of the Code for foreign governments (including sovereign wealth funds) of offending foreign countries.
• Modify the application of the base erosion and anti-abuse tax (BEAT) to: 1) domestic corporations (other than publicly held corporations) that are majority owned by foreign persons resident in offending countries that have adopted unfair taxes, and 2) U.S. branches of foreign corporations in offending countries. These “Super BEAT” provisions, in effect, eliminate the $500 million gross receipts threshold for BEAT, add back certain tax credits for determining liability under BEAT, reduce the base erosion percentage threshold to 0.5% and increase the general BEAT tax rate to 14% under the Senate bill (as opposed to 10% under the House bill).

New section 899, if enacted, would impact payments of U.S.-sourced FDAP income and payments with respect to dispositions of or distributions attributable to gain from the sale of U.S. real property interests made to applicable persons. The Senate bill defines an “applicable person” as any of the following:

• An individual (other than a U.S. citizen or resident) who is a tax resident of an offending foreign country.
• A foreign corporation (other than those that are majority U.S.-owned) that is a tax resident of an offending foreign country.
• A foreign corporation (other than a publicly held corporation) more than 50% owned, directly or indirectly, by vote or value, by applicable persons.
• A private foundation that is created or organized in an offending foreign country.
• A foreign government of an offending foreign country.
• A trust the majority of the beneficial interests of which are directly or indirectly held by applicable persons
• Any other entity (including branches) identified with respect to an offending foreign country by the Treasury Secretary.

While the bill remains under consideration in the Senate, it is important to understand the implications for investors that are residents of offending countries and for withholding agents (U.S. or foreign) that may make payments to residents of offending foreign countries and who will ultimately be responsible for withholding and remitting the taxes due under these rules.

If passed, the bill could impact payments as early as Oct. 1, 2025, or Jan. 1, 2027, under the House or Senate versions, respectively. That does not give withholding agents much time to update systems and procedures, communicate with investors, evaluate investment strategies or train key stakeholders on changes in the rules.

Additionally, the Treasury will likely need time to enact coordinating regulations and update U.S. tax information returns (such as Forms 1042 and 1042-S) and related form instructions, as well as U.S. tax withholding certificates (such as Forms W-8) to include additional fields and guidance relevant for implementing requirements. As such, a delayed effective date or administrative relief may be necessary to allow for negotiations and the implementation of procedures for a section 899 enactment and application.

Exceptions and safe harbors

The additional tax increase imposed under section 899 with its 5% annual increase up to a maximum of 15% as set forth under the Senate bill would apply to:

1. The 30% statutory rate imposed on payments of U.S. sourced FDAP income
2. Income taxes on effectively connected income of non-U.S. persons
3. Taxes on payments with respect to dispositions or distributions of or attributable to gain from the sale of U.S. real property interests under FIRPTA

Notably, while the House version of the bill generally only provided legislative commentary regarding how section 899 would impact the availability of certain statutory exemptions or exceptions from withholding, the Senate version explicitly states that several exemptions from withholding will remain in place—including the exemptions under sections 881(c) and (e) for portfolio interest and certain other interest, including interest-related dividends under section 871, as well as the exemption for original issue discount (OID) on short-term obligations.

Likewise, the Senate bill makes clear that section 899 does not apply to value-added tax (VAT), estate and gift tax or income tax imposed on residents or citizens of offending countries. Nor does it apply to the preferential 14% rate of withholding applied to students, researchers, scholarship and grant recipients under section 1441(b).

Section 899 also includes two safe harbor provisions for failures to withhold that occur prior to Jan. 1, 2027. First, under the bill, section 899 withholding would not be required if the offending foreign country is not listed by the Treasury Secretary as an offending foreign country at the time the withholding agent issued the payment to the payee.

Second, additional withholding under section 899 would not apply to foreign corporations and trusts that are treated as applicable persons due to the fact that they are owned by applicable persons, but only if the offending foreign country(s) that they are a resident of has been listed as such by the secretary for less than 90 days.

Finally, there is a general safe harbor for withholding agents, which states that no penalties or interest would be imposed for failures to withhold and remit the additional withholding tax if the withholding agent can show to the secretary’s satisfaction that it made best efforts to comply with the increased rates in a timely manner. It is unclear what enforcement mechanisms would be put in place, but the availability of relief through the above safe harbors, and through showing reasonable cause, provides some relief for withholding agents who may be scrambling to implement these provisions.

Navigating common challenges

Organizations challenged with navigating specific provisions in newly proposed section 899 and those evaluating their current structures and investment strategies for the impact of section 899 should consider the following:

Income subject to reduced withholding under treaty: Proposed Section 899 in the Senate’s initial draft of legislation does not directly alter benefits derived from an income tax treaty. Therefore, payees that are not U.S. residents may still claim reduced rates of withholding under provisions of a tax treaty, but section 899 may partially or completely offset the lower rates afforded under a treaty.

For example, if an investor resident in an offending country was paid dividends and provides a tax withholding certificate claiming entitlement to a treaty that provides for a 0% rate of withholding on U.S.-sourced dividends, under the Senate version of the bill, section 899 would operate to increase that rate to 5% the first year, 10% the second year and 15% the third year that the jurisdiction is designated as an offending foreign country. If the applicable treaty rate is 15%, section 899 may operate to raise this rate to 20% the first year, 25% the second year and 30% the third year.

If the payee is a resident of a country that does not have a tax treaty with the United States and it is designated as an offending foreign country under section 899, the withholding rate would be 30% under section 1441, plus 5% under proposed section 899 in the Senate bill for a total withholding tax rate of 35% the first year, 40%, the second year, capped at 45% the third year (30% statutory rate plus the max 15% under the Senate version of Section 899), and capped at 50% in the fourth year under the House version of section 899, in which the maximum rate increase was 20%).

Effectively connected income/Foreign Investment in Real Property Tax Act (FIRPTA): While the initial version of the House bill was aimed primarily at U.S.-sourced FDAP income under sections 1441, 1442, and 1443 of the Code and included other types of taxes, such as those imposed under section 1445 for FIRPTA, FIRPTA was removed from the version of the bill that the House ultimately passed.

However, under the Senate’s initial draft, FIRPTA and some of these provisions have been added back into the bill, and the definition of unfair foreign taxes has been expanded to include any tax imposed on a U.S. person by a foreign government that directly or indirectly disproportionately impacts U.S. persons. Therefore, while the House bill did not include a provision applying the increased section 899 withholding to FIRPTA, the Senate bill applies section 899 to FIRPTA taxes. As a result, offshore vehicles and foreign investors with interests in U.S. real property may see additional taxes imposed along with changes in the documentation that they may be required to provide (such as Forms W-8).

The Senate version of the bill provides some relief, however, by explicitly stating that some section 897 exceptions on U.S. real property gains for domestically controlled real estate investment trusts (REITs) and foreign pensions will remain intact. However, many real estate-related investments will involve structures and financing transactions involving REITs. U.S. REITs, which are generally required to distribute their taxable income annually to maintain their REIT status, may find it more difficult to attract capital from applicable persons in offending foreign countries due to the increased withholding taxes that could apply to REIT dividends.

Chapter 3 (Withholding on payments to foreign persons): Under existing U.S. withholding rules, the current rate of withholding imposed on nonresident aliens for payments of FDAP income (such as interest, dividends, rents and royalties) is 30% and can be reduced by treaty or in some instances by statute.

Under newly proposed section 899, an increase of 5% would be applied each year a foreign country is considered an offending foreign country, capped at 15% under the Senate bill as opposed to 20% under the House bill. Income typically exempted from withholding under chapter 3 of the Code would generally remain exempt. This includes portfolio interest, bank-deposit interest and income paid to section 501(c)3 entities (generally claimed on a Form W-8 EXP) which would remain exempt under the  Senate’s initial draft of legislation.

Under the respective House and Senate bills, withholding agents would need to track, capture and report any additional taxes withheld under section 899 on a U.S. tax information return (likely Form 1042-S). The Treasury will likely need time and resources to modify any applicable forms and related instructions, so it is unclear whether the October implementation date in the House bill will stick.

Additionally, it should be noted that under proposed section 899, income paid to foreign foundations would not retain its reduced excise tax rate of 4%. Instead, the bill proposes a tiered system that would increase the excise tax rate on net investment income for larger foundations with assets over $5 billion to 5%, while maintaining the current 1.39% rate for smaller foundations.

The increased rate of excise tax is a critical development particularly for large private foundations, whose grant-making capability may be impacted by the changes. They will need time to request budget; perform required updates to systems, policies and procedures; and train key stakeholders on changes in the rules as needed to comply with new requirements.

Finally, the Treasury will likely need time and resources to modify any applicable forms and related instructions and may need to update tax information returns and withholding certificates, such as forms W-8, to include fields and certifications for foundations that are residents of offending foreign countries. Again, a delayed effective date beyond October 2025 may be necessary to allow for the implementation of procedures for its enactment and application. Similar changes to U.S. withholding tax regimes have typically taken at least 18 months for withholding agents (U.S. or foreign) and controlled foreign corporations in the group to implement, so be sure to plan ahead.

Section 892 (Investment income of foreign governments): The Senate and House bills explicitly state that non-U.S. governments from countries identified as offending foreign countries may lose their section 892 exemption. Section 892 generally exempts non-U.S. governments and their controlled entities from U.S. federal income tax on investments in U.S. stocks, bonds and other securities (if the income is not derived from commercial activities). This would include payments on stocks and bonds held by sovereign investment funds and monetary authorities along with entities classified as integral parts of an offending foreign countries or offending foreign country (term used in the Senate bill) governments. Administratively, this may lead to significant reevaluation of blocker structures implemented by private investment funds traditionally used to insulate once-exempt entities.

If passed, proposed section 899 would disallow this exemption for non-U.S. governments that are designated as applicable persons of offending foreign countries under section 899 and would significantly impact the exemption currently afforded to these governments. The House-approved section 899 provisions that increase the substantive rates of tax (sections 871, 881, 882, 884 and 4948), deny the section 892 exemption for foreign governments and propose that Super BEAT rules would apply on the first day of the first calendar year beginning on or after the latest of the following dates:

• Ninety days after the date section 899 was enacted
• One hundred and eighty days after the date the unfair foreign tax was enacted
• The first date that an unfair foreign tax begins to apply.

If section 899 is enacted before October 2025, these provisions may begin applying starting Jan. 1, 2025, for countries that have a digital services tax (DST), undertaxed profits rule (UTPR) or diverted profits tax (DPT) in force on Jan. 1, 2026, that applies to U.S. persons or their controlled foreign corporations.  If section 899 is not enacted until later in 2025 or 2026, section 899 may not apply until 2027.

Notably, all of these challenges could have a significant impact on investment funds and their foreign investors. For example, offshore funds classified as corporations for U.S. federal income tax purposes, including foreign feeders and blockers, could be subject to tax increases if they are owned 50% or more by investors that are residents of offending countries.

Likewise, the U.S. tax withholding rate on dividends paid by U.S. blocker corporations that are majority-owned by investors that are residents of offending foreign countries could be increased if the recipient is an applicable person. The domestic blocker could also be subject to the Super BEAT. Such “domestic blockers” are commonly established to hold interests in U.S. operating businesses, to engage in U.S. direct lending or to hold interests in U.S. real estate assets.

Any fund-level tax increases could affect all investors, subject to any provisions in fund agreements that may allocate the increases only to applicable persons. Further, as these rules look to both direct and indirect ownership, fund managers and other service providers may need to conduct significant diligence on fund investors to determine the effects on the fund vehicles.

Section 899 poses various challenges for withholding agents and foreign payees

If enacted, section 899 would mean significant changes for withholding agents and foreign payees. Withholding agents tasked with implementation would need to update their systems and processes to incorporate these changes in order to ensure compliance, and foreign investors would face additional costs associated with withholding, as well as new documentation requirements.

Companies and investors can consult experienced tax information reporting and withholding specialists and international tax professionals to get assistance with:

• Reviewing their structures
• Evaluating the impact of these rules
• Assessing readiness for compliance
• Implementing systems, policies and procedures for complying with section 899

Section 899 removed from tax package

While the U.S. Senate worked to finalize its version of the taxation-and-spending bill, Treasury Secretary Scott Bessent on June 26 announced a tax agreement with G7 countries, about which he did not disclose details.

As a result of that agreement, he recommended that Congress remove the proposed section 899 from its legislation. Republican congressional leaders subsequently announced they would heed that recommendation.

Republican leaders are aiming to enact the taxation-and-spending bill by July Fourth.