Executive Summary

• Retaliatory tax provisions contained in H.R. 1, the “One Big Beautiful Bill Act” that recently passed the US House of Representatives, if enacted, would drastically impact common cross-border transactions, including US operations of foreign multinational groups and inbound investments. 
• New Code Section 899¹ targets “applicable persons” with respect to countries that have adopted “unfair foreign taxes,” defined to include the undertaxed profits rule tax under the Organisation for Economic Co-operation and Development’s (OECD) Pillar 2, digital services taxes, diverted profits taxes, and other taxes identified by the US secretary of the treasury. 
• Applicable persons would initially see their US tax rates increase by five percentage points, and these rates would increase by an additional five percentage points annually until they reach 20 percentage points higher than applicable statutory rates. 
• US subsidiaries of applicable persons would be subject to a modified version of the base erosion and anti-abuse tax (BEAT) in Code Section 59A, referred to as the “Super BEAT.” 
• Common cross-border transactions would be drastically impacted by this new Code section if it were enacted.

This alert describes the persons who would be subject to the changes contained in Code Section 899, the consequences of being subject to this proposed new Code section, and some of the impacts this provision would have on certain cross-border transactions. 

Summary of Code Section 899

Applicability 

Code Section 899 imposes retaliatory taxes on “applicable persons” resident in “discriminatory foreign countries,” which are defined as countries that impose unfair foreign taxes (UFTs). A list of discriminatory foreign countries would be published quarterly by the US Department of the Treasury. The “applicable persons” subject to increased taxes include individuals and corporations resident in discriminatory foreign countries, as well as foreign corporations more than 50% (by vote or value) owned directly or indirectly by such applicable persons (unless such majority-owned corporations are publicly held). Subsidiaries of US-parented multinational groups would generally not be applicable persons.

Three categories of taxes are identified as “per se” UFTs: undertaxed profits rule taxes imposed pursuant to the OECD’s Pillar 2, digital service taxes, and diverted profits taxes. The following countries have adopted these taxes: 

Undertaxed Profits Rule Taxes

Australia, Austria, Belgium, Bulgaria, Croatia, Cyprus, Czech Republic, Denmark, Finland, France, Germany, Greece, Hungary, Indonesia, Ireland, Italy, Japan, Lichtenstein, Luxembourg, Macedonia, Netherlands, New Zealand, Poland, Portugal, Romania, Slovenia, South Korea, Spain, Sweden, Thailand, Turkey, and the United Kingdom.² 

Digital Service Taxes

Austria, Canada, France, Guinea, Italy, Nepal, Rwanda, Sierra Leone, Spain, Tunisia, Turkey, Uganda, the United Kingdom, and Zimbabwe.³ 

Diverted Profits Taxes

Australia and the United Kingdom.⁴ 

In addition to the foregoing categories of per se UFTs, the US secretary of the treasury may identify as UFTs other taxes that are “discriminatory,” “extraterritorial,” or “enacted with a public or stated purpose indicating the tax will be economically borne, directly or indirectly, disproportionately by US persons.” However, certain categories of taxes, including value-added taxes, goods and services taxes, and sales taxes, are exempted from being classified as UFTs. When a country repeals all of its UFTs, it generally will cease to be a discriminatory foreign country, and persons associated with that country generally will cease to be applicable persons.

Retaliatory Tax Provisions

The retaliatory tax provisions in Code Section 899 mainly fall into two categories: (1) increased rates of US tax on applicable persons, and (2) a more stringent version of the BEAT currently contained in Code Section 59A, referred to as the “Super BEAT.”

Increased Rates of US Tax on Applicable Persons

The rates of US tax to which applicable persons are subject would be increased five percentage points each year, most likely beginning in 2026, until the rates reach a maximum of 20 percentage points above the current statutory rates (determined without regard to any treaty). The applicable US tax rates that would be subject to increase include (1) the 30% withholding tax on passive US-source income (e.g., dividends, interest, rent, and royalties), (2) the 21% corporate income tax, and (3) the 30% branch profits tax imposed on the nonreinvested earnings of a US trade or business conducted by a foreign corporation. Income tax rates applicable to individual applicable persons would also increase, but only for dispositions of US real property interests that are treated as US trade or business income under the US “FIRPTA” rules.

Income that is currently statutorily exempt from US tax—such as US-source interest income that qualifies for the “portfolio interest” exemption—would, generally speaking, remain exempt from US tax; however, Code Section 899 expressly overrides the US tax exemption for sovereign wealth funds and other foreign governmental entities contained in Code Section 892. 

In the case of applicable persons that qualify for a zero or reduced rate of tax pursuant to an income tax treaty, the increased tax rate to which the applicable person is subject would initially be five percentage points above the applicable treaty rate, although the rate would climb five percentage points each year until it reached 20 percentage points above the maximum statutory rate (determined without regard to a treaty). Importantly, Code Section 899 would apply to income that is currently subject to a reduced rate under a treaty, thereby treating domestic statutory exemptions (like the portfolio interest exemption, mentioned above) different from reductions in an applicable tax rate pursuant to a treaty.⁵

The Super BEAT

In addition to the current BEAT in Code Section 59A, which was adopted as part of the 2017 Tax Cuts and Jobs Act, Code Section 899 would impose a modified “Super BEAT” on US corporations that are more than 50% owned (by vote or value, directly or indirectly) by applicable persons.

Several aspects of the Super BEAT would make it more likely for targeted companies to be liable for the BEAT. First, certain thresholds that limit the applicability of the regular BEAT would be removed. The current BEAT only applies to US subsidiaries (1) of multinational groups with gross receipts of at least US$500 million, and (2) whose “base erosion” payments—i.e., deductible payments to related foreign persons—exceed 3% of total deductions (or 2% in the case of certain financial firms). These thresholds would not apply under the Super BEAT, potentially subjecting US companies to the Super BEAT despite not being part of large multinational groups or making significant related-party payments.

Second, the Super BEAT would include several other modifications to the current BEAT:

• An increase in the BEAT tax rate from 10% to 12.5%;
• An additional limitation on using credits to offset BEAT liability;
• An expansion of the definition of base erosion payments to include payments on which US tax was already imposed or withheld as well as certain payments that would be base erosion payments but for the fact that they are required to be capitalized; and
• An elimination of the exception under the standard BEAT for intercompany payments using the “service cost method.”⁶ 

The new Super BEAT would potentially both increase the tax liability of current BEAT taxpayers and subject additional US companies to the BEAT.

Application to Common Cross-Border Transactions

Direct Operation in the United States

A non-US company that operates directly or through a flow-through entity or branch in the United States (Non-US Opco) generally earns income effectively connected with a US trade or business (ECI) and may also be subject to the branch profits tax on that income (subject to the provisions of an applicable tax treaty). See Figure 1.

Under Code Section 899, if Non-US Opco is an applicable person, the rate of US federal income tax to which it is subject would potentially increase over four years to as high as 41% (based on the current federal 21% statutory rate of income tax), and the rate of US branch profits tax to which its earnings are subject would potentially increase to as high as 50% (based on the current 30% statutory rate of the branch profits tax). Non-US Opco’s new combined US federal tax rate resulting from the interaction of US corporate income tax and the branch profits tax would potentially be as high as 70.5%, up from 44.7% under current law.

Operations in the United States Through a Corporate Subsidiary

A domestic corporate subsidiary of a multinational group (US Sub) is generally subject to US corporate income tax on its worldwide income and, if the gross receipts and base erosion thresholds are satisfied, may also currently be subject to the BEAT. See Figure 2. The removal of the gross receipts and base erosion thresholds may cause US Sub to become subject to the Super BEAT when it otherwise would not have been subject to the current BEAT. In addition, the rate of tax imposed under the Super BEAT will increase from 10% to 12.5%, an increase over the regular BEAT tax rate. 

Further, dividends that US Sub pays to a non-US parent will be subject to an increased rate of US withholding tax if the parent is an applicable person. Even though the dividends may currently qualify for a reduced (or zero) rate under an applicable tax treaty, the maximum applicable US withholding tax rate would potentially increase to as high as 50% (based on the current 30% statutory rate). 

Passive Investment in the United States

A non-US person that passively invests in the United States (Non-US Investor) generally earns passive US-source income (e.g., dividends, interest, rent, or royalties) that is subject to a US federal withholding tax of 30% (subject to reduction under an applicable tax treaty). See Figure 3. If Non-US Investor is an applicable person, the rate of US federal withholding tax to which it is subject under Code Section 899 would potentially increase the withholding tax rate to as high as 50% (based on the current 30% statutory rate). If Non-US Investor currently benefits from a reduced (or zero) treaty rate, the increased rate will begin at five percentage points above the treaty rate. If Non-US Investor is a foreign governmental entity that currently benefits from the Code Section 892 exemption, the new US tax rates to which Non-US Investor will be subject will be determined without regard to that exemption. 

It is more likely that a US blocker corporation through which Non-US Investor holds (directly or indirectly) ECI-generating investments (US Blocker Corporation) will be subject to the new Super BEAT than the current BEAT. However, proceeds from the liquidation of a US blocker corporation received by Non-US Investor should generally remain exempt from US tax.

Financing Investment in the United States

A non-US company that lends to a US resident borrower (Non-US Lender) generally earns US-source interest income that may be (1) ECI (potentially also subject to the branch profits tax), (2) subject to a statutory 30% US withholding tax, (3) eligible for a reduced rate of withholding provided by an applicable tax treaty, or (4) eligible for an exemption from withholding under the portfolio interest exemption, depending on the nature and extent of its US activities. See Figure 4. As discussed above, if Non-US Lender is an applicable person and treats the interest income as ECI, it could potentially be subject to US corporate income tax at rates as high as 41%, with an additional branch profits tax as high as 50%. If the interest income of Non-US Lender is not otherwise ECI, the rate of US federal withholding tax to which it is subject would potentially increase to as high as 50% (based on the current 30% statutory rate), although the portfolio interest exemption would potentially still be available. Importantly, the portfolio interest exemption is not available to banks extending credit in the ordinary course of business, so the differential impact of Code Section 899 on treaty-based reductions or exemptions from US withholding tax on interest may impact bank lenders more than unrelated nonbank lenders that may be eligible for the portfolio interest exemption. 

In response to these increased tax rates, Non-US Lender likely would consider increasing the rate of interest it charges US borrowers in order to maintain the margin it makes above its own borrowing costs, or request to be grossed up by the relevant US borrower for the increased taxes under the rationale that Code Section 899 is a change in applicable law. A US borrower may argue that the impact of Code Section 899 is expected at the time a new loan agreement is entered into and depends on Non-US Lender’s jurisdiction of organization (and on laws, rules, or practices implemented by the government of such jurisdiction), which is outside of the borrower’s control, but that argument may result in Non-US Lender pricing in a risk that is out of the control of both parties.

Conclusion

The retaliatory tax provisions in Code Section 899, if enacted, would have a significant and potentially negative impact on a wide variety of cross-border transactions, including US operations of foreign multinational groups (whether conducted directly or through a domestic subsidiary) and ordinary course inbound investments. The proposal is now under consideration in the US Senate, where changes to the H.R. 1 are likely. Regarding Code Section 899 in particular, the US Senate is expected to balance concerns about the impact of Code Section 899 on foreign direct investment, the value of the US dollar, and interest rates, against the possibility that the proposed Code provision could help US companies by persuading countries with UFTs to modify or repeal those taxes. 

There is still an opportunity for interested stakeholders to help shape this discussion and the outcome of the proposal. Please contact any of the authors of this alert for further information about Code Section 899 and how you can impact the policy debate in Congress.