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.