Proposed Section 899, which passed the House of Representatives May 22, 2025, as part of the tax reconciliation bill, would respond to "unfair foreign taxes" by imposing increased US tax rates on certain entities and individuals from "discriminatory foreign countries." If enacted, this provision would have significant implications for the asset management industry as it would impact certain cross-border income flows that are generally earned by hedge funds, private equity funds and their portfolio companies, regulated investment companies (RICs), lending funds, business development corporations (BDCs), real estate investment trusts (REITs), collective investment vehicles (CIVs) (including UCITS-compliant vehicles), and sovereign wealth funds.

The application of proposed Section 899 would vary depending on the specific ownership structure and the source and type of income involved. For example, the initial question would be whether US tax would apply to the type of US-source income received by an "applicable person." For example, proposed Section 899 would specifically eliminate the exemption under IRC Section 892(a) for any government of any discriminatory foreign country defined as an applicable person. However, further analysis would be required to determine the applicability of Section 899, as discussed later.

Although the House has approved the budget reconciliation bill that includes proposed Section 899, this provision could change in the Senate.

This Tax Alert expands upon the discussion in Tax Alert 2025-1085, dated May 16, 2025, of proposed Section 899 by focusing on potential issues that will need to be analyzed for various asset management structures and scenarios. This discussion, however, does not address any US income tax considerations that may arise from Section 899's proposed expansion of the base erosion and anti-abuse tax (BEAT) under IRC Section 59A (these provisions would be relevant to corporate asset managers operating in different countries, and are discussed in Tax Alert 2025-1085). This Alert also does not address the provisions of IRC Section 891.¹

Exempt income under proposed Section 899

Under proposed Section 899, a "specified rate of tax" (or any rate of tax applicable in lieu of such statutory rate) that applies to an "applicable person" would increase by an "applicable number of percentage points." The specified rates of tax include the 30% rate of tax imposed on "fixed or determinable annual or periodical" (FDAP) income (e.g., under IRC Section 881). According to an accompanying House Budget Committee report, proposed Section 899 would not apply to income that is explicitly excluded from the application of the specified tax because the provision would only increase the specified tax rates. Thus, for example, the report states that the provision would not apply to portfolio interest, to the extent that portfolio interest were excluded from the tax imposed on FDAP income. For similar reasons, it appears that the bill is intended not to apply to US-source income that qualifies for a statutory exemption such as bank deposit interest, interest-related dividends under IRC Section 871(k), certain short-term capital gain dividends, and certain income earned by qualified foreign pension funds under IRC Section 897(l).

Because capital gains that are not considered gains from US real property interests (i.e., non-Foreign-Investment-in-Real-Property-Tax-Act (FIRPTA) capital gains) are generally sourced by residence of the seller, such gains recognized by a foreign person directly or through one or more partnerships appear to be outside the scope of proposed Section 899.

Income subject to proposed IRC Section 899

If enacted as proposed, Section 899 would increase the tax rate imposed on certain US income received by foreign persons who are "applicable persons."

Definition of "applicable person"

An "applicable person" includes:

• Any government (as defined in IRC Section 892) of a discriminatory foreign country
• Any individual (other than a citizen or resident of the US) who is a tax resident of a discriminatory foreign country
• Any foreign corporation (other than a "US-owned foreign corporation") that is a tax resident of a discriminatory foreign country
• Any private foundation created or organized in a discriminatory foreign country
• Any non-publicly held foreign corporation where more than 50% of the vote or value is owned directly or indirectly by applicable persons
• Any trust or similar entity whose beneficial interests are majority-held by applicable persons
• Any foreign partnerships, branches or any other entity identified with respect to a discriminatory foreign country by the Secretary for purposes of Section 899

A US-owned foreign corporation is defined as any foreign corporation that has 50% or more of its stock, by vote or value, held directly (or indirectly through certain foreign entities and by way of option attribution) by United States persons.

The term "discriminatory foreign country" means any foreign country with one or more "unfair foreign taxes." The term "unfair foreign tax" expressly includes three categories of taxes: undertaxed profits rules (UTPRs), digital services taxes (DSTs), and diverted profits taxes (DPTs). In addition, the definition of unfair foreign taxes includes certain extraterritorial or discriminatory taxes but only to the extent provided by the Secretary. While proposed Section 899 does not define a DST, a memorandum issued on February 21, 2025 by the White House indicated that the following countries have DSTs: Austria, Canada, France, Italy, Spain, Turkey, and the United Kingdom. Countries with a UTPR in force include most countries in the European Union, the United Kingdom, Australia, South Korea and Japan. See EY's BEPS 2.0 website for more information, including a tracker of latest BEPS developments.

Application to funds

The impact of proposed Section 899 would depend, in many instances, on the tax classification of the fund vehicle.

Partnership structures

For entities structured as partnerships — such as many hedge funds, credit funds and private equity funds — taxation generally applies at the partner level. Accordingly, the key consideration would generally be whether the partner/investor is an applicable person. Because "applicable person" includes any foreign partnership identified by the Secretary as an applicable person with respect to a discriminatory foreign country, further guidance could be forthcoming on applying proposed Section 899 to foreign partnerships. For example, further guidance could apply proposed Section 899 to hybrid entities treated as tax residents of discriminatory foreign countries for their tax purposes but as partnerships or disregarded entities for US tax purposes.

• Limited partners (LPs) with IRC Section 892 or treaty benefits: LPs in a fund that could previously claim the benefit of IRC Section 892 or a tax treaty to reduce or eliminate withholding tax could (depending on the jurisdiction of their residence) fall within the scope of proposed Section 899, resulting in the possibility of increased withholding rates for those investors. For example, a sovereign LP that is an applicable person could be subject to increased rates of withholding on dividends (up from the current 0% rate).

Corporate structures

A foreign corporation, including a CIV or foreign mutual fund, could be an applicable person — and thus in scope of proposed Section 899 — if it is either (1) established in a jurisdiction imposing discriminatory taxes (unless it is considered a US-owned foreign corporation) or (2) not publicly traded and is more than 50% owned by applicable persons (by vote or value). If either condition were to apply, proposed Section 899 would apply at the entity level.

• Example 1: A foreign corporation, such as a CIV, that is resident in a discriminatory foreign country and is at least 50% owned by non-US persons is defined as an applicable person and would be within proposed Section 899's scope.
• Example 2: A Cayman feeder of an investment fund, which has elected to be treated as a corporation for US federal tax purposes and is more than 50% owned by applicable persons (e.g., investors from jurisdictions with discriminatory taxes), would be in scope.
• LPs with treaty benefits: LPs in a fund vehicle, which has elected to be treated as a corporation for US federal tax purposes, could be in scope (depending on where they reside), even if they could previously claim the benefit of a tax treaty to reduce or eliminate withholding tax (e.g., the fund vehicle was fiscally transparent from their home country's perspective). As a result, these investors could face increasing rates of withholding.

BDCs and RICs

For BDCs and RICs, proposed Section 899 would primarily affect the rate of US tax imposed on distributions received by applicable persons unless those distributions qualify as interest-related dividends or short-term capital gain dividends that qualify for the statutory exemption under IRC Section 871(k). Foreign-source capital gains from the sale or exchange of interests in BDCs and RICs also appear to fall outside the scope of proposed Section 899.

REITS

For REITs, regular dividends would be subject to the increased tax rates under proposed Section 899, if such dividends were derived by applicable persons. Similarly, a distribution that is attributable to the sale of US real property interests and received by an applicable person would generally also be subject to proposed Section 899's rate increases unless the distribution were received by a qualified foreign pension fund entitled to the benefits of IRC Section 897(l). As noted above, proposed Section 899 does not appear to affect the operation of Section 897 (l).

Treaty-based funds

Funds that have sought to qualify, at the fund-level, for treaty benefits by meeting the treaty's limitation-on-benefits clause could be directly affected by proposed Section 899. The impact, however, appears to depend on the fund's entity classification. If the fund were to be treated as a corporation for US tax purposes and owned 50% or more by US persons, it could be out of proposed Section 899's scope. If the fund were structured as a partnership, however, further guidance would be needed on applying proposed Section 899 to the partnership.

Applicable US-source income categories and tax rate increases

Conclusion

Given the broad reach of proposed Section 899 and its potential to elevate US withholding taxes to rates as high as 50%, asset managers and portfolio companies, as well as their brokers, custodians, fund administrators, and advisors, must carefully assess their structures and investor profiles. Additional planning and due diligence will be essential to reduce exposure and ensure compliance with these new rules.