On December 15, 2025, the Treasury Department and IRS issued long-awaited final regulations (TD 10042) (final IRC Section 892 regulations or final regulations), along with temporary and proposed regulations (REG-101952-24) (proposed IRC Section 892 regulations or proposed regulations), under IRC Section 892.

Under IRC Section 892, foreign governments are generally exempt from US income taxation on certain qualified income received from US investments. The exemption does not apply to income from "commercial activity," or received by or from a "controlled commercial entity" (CCE), or income received from a disposition of an interest in a CCE.

The final regulations generally follow the approach of proposed rules from 2011 (2011 proposed regulations) (REG-146537-06) and 2022. They clarify when income of a foreign government is considered from commercial activity or from a CCE and thus not exempt under IRC Section 892, versus income from passive investment activity, which is exempt. Specifically, the final IRC Section 892 regulations:

• Define commercial activity broadly as any activity that is "ordinarily" conducted for the current or future production of income or gain, even if that activity does not constitute a trade or business under IRC Section 864(b)
• Provide a more detailed definition of an investment in a "financial instrument," the income from which is treated as exempt investment income
• Limit the United States Real Property Holding Corporation (USRPHC) "per se" CCE rule to domestic corporations and do not treat any foreign corporations as engaged in commercial activity solely because they are USRPHCs (a departure from the 2011 proposed regulations)
• Attribute commercial activities conducted by a partnership to its partners, unless the partner holds a "qualified partnership interest" in the partnership (a replacement of the "limited partner" exception in the 2011 proposed regulations)
• Provide relief from CCE status for entities that inadvertently conduct commercial activity, if the inadvertent activity is timely cured (within 180 days of its discovery) and record maintenance requirements are satisfied

The proposed IRC Section 892 regulations include new rules on when (1) the acquisition of debt by a foreign government is considered investment activity instead of commercial activity, and (2) a foreign government is considered to have "effective control" over an entity for purposes of determining whether the entity is a CCE.

This Tax Alert summarizes certain key aspects of the final and proposed IRC Section 892 regulations.

Background

IRC Section 892 exempts from US taxation certain income received by a foreign government, including income from investments in US stocks or securities, with some exceptions. The IRC Section 892 exemption does not apply to income that is (1) from commercial activity, (2) received by or from a CCE (defined as an entity that is engaged in commercial activities anywhere, not just in the United States, in which the foreign government holds a controlling interest or over which it has "effective control"), or (3) from the disposition of a CCE.

Proposed regulations released in 2022 would treat a USRPHC as engaged in commercial activity and thus a CCE if it meets certain foreign government ownership and control thresholds (see Tax Alert 2023-0059).

Final IRC Section 892 regulations

Commercial activities

Treas. Reg. Section 1.892-4 outlines the rules for determining when income earned by a foreign government is considered income from commercial activity and thus excluded from the general tax exemption under IRC Section 892. The final regulations clarify that any activity typically conducted for income or gain is considered commercial, regardless of the foreign government's motivations. The final regulations use a broad definition of commercial activities, including those that may not qualify as a US trade or business under IRC Section 864(b). They also clarify that IRC Section 892 considers activities qualifying as a trade or business under IRC Section 162 (if undertaken in the United States) or a trade or business in the United States for purposes of IRC Section 864(b) to be commercial, unless specifically excluded.

The final regulations specify activities that are not considered commercial for these purposes. These activities include holding investments in stocks, bonds, securities, loans, financial instruments, partnership equity interests, net leases, non-income-producing real property and bank deposits. In addition, engaging in trades, including trades of stocks, bonds, partnership equity interests, financial instruments and commodities for the foreign government's own account, is also not considered commercial activity, unless the foreign government is acting as a dealer.

The mere holding of a partnership interest or selling the interest for the foreign government's own account is not treated as commercial activity. Investments in certain derivatives that are included in the final regulations' definition of "financial instruments" are generally not considered commercial activity, on the grounds that investing and trading in those financial instruments generally involves only putting capital at risk rather than more commercial activities such as structuring the instrument, although certain exceptions apply. If general federal income tax principles characterize a contract or other financial instrument as resulting in beneficial ownership of the underlying asset, the determination of whether the foreign government investor is conducting commercial activity is based on ownership of that asset, not the financial instrument. The Preamble to the final regulations notes that commercial activities conducted by a partnership may be attributed to a foreign government partner, and a foreign government's distributive share of partnership income from commercial activities is not exempt from tax under IRC Section 892.

In response to comments, the Preamble to the final regulations notes that the treatment of certain fee income in relation to private equity or a private credit fund must be evaluated based on the nature of activity performed by, or attributed to, the foreign government; for example, a foreign government investor is considered to conduct commercial activity to the extent a fund sponsor's commercial activities are attributable to a foreign government investor in a privately managed fund, unless an exception applies.

The final regulations also introduce a more detailed and expanded definition of "financial instrument," expressly including a broad range of derivatives such as interest rate, currency, equity and commodity notional principal contracts, as well as options, forwards, futures and similar contracts.

In a helpful change, the final regulations do not consider a non-US corporation that is a USRPHC to be considered engaged in commercial activity "per se."

Controlled commercial entity

Treas. Reg. Section 1.892-5 clarifies that the exemption generally applicable to a foreign government for income described in Treas. Reg. Sections 1.892-3T and -3 does not apply to income received by or from CCEs, or from the disposition of interests in those entities. The definition of "entity" in Treas. Reg. Section 1.892-5 is for purposes of IRC Section 892(a)(2)(B) only, and includes corporations, partnerships, trusts (including pension trusts) and estates. A CCE is any entity engaged in commercial activities if a foreign government owns directly or indirectly at least 50% of its value or voting power or otherwise has effective control of the entity. The final regulations replace "effective practical control" with the term "effective control" to be consistent with IRC Section 892(a)(2)(B)(ii). The proposed regulations contain rules for defining effective control, discussed later.

The final regulations adopt the 2011 proposed regulations' exception for "inadvertent commercial activity," and establish that an entity conducting only inadvertent commercial activity is not considered engaged in commercial activities if three conditions are met: (1) the failure to avoid the activity was reasonable, (2) the activity is timely cured, and (3) proper records are maintained.

Whether failure to avoid commercial activity is reasonable is a facts-and-circumstances determination, considering ongoing due diligence, adequate written policies, communication to responsible parties, advance investment determinations, annual audits and certification of compliance.

The final regulations, like the 2011 proposed regulations, provide a safe harbor that applies if the assets and income from commercial activities do not exceed 5% of the assets reflected on the entity's balance sheet for the tax year as prepared for financial accounting purposes. The safe harbor must be applied using an applicable financial statement as defined in IRC Section 451(b)(3) and Treas. Reg. Section 1.451-3(a), which may include a financial statement prepared in accordance with US GAAP, IFRS or another method required under applicable regulatory accounting rules. The determination of asset values is made using the average of the value of the assets as of the close of each quarter of the tax year, and the determination of income is made as of the end of the tax year.

If commercial activity is discovered, it must be discontinued or cured within 180 days of the date of discovery to preserve exemption eligibility, and records of the incident and cure must be maintained.

CCE status is determined annually, considering both the current and immediately preceding tax year. Special rules apply to corporate acquisitions involving entities engaged in commercial activities, particularly when the transaction occurs between entities controlled by the same foreign sovereign. Even though the regulatory test spans only the current and immediately preceding tax year, the Preamble to the final regulations states that other doctrines may apply in making the commercial activity determination for activities that occur across multiple years in form, but only one year in substance.

USRPHCs

The final IRC Section 892 regulations revoke the rule that a non-US entity that is a USRPHC is deemed to be engaged in commercial activities. However, US corporations that are USRPHCs are generally still deemed to be engaged in commercial activities. The 2022 proposed regulations contained a "minority-interest exception," under which a corporation that is a USRPHC solely because of its ownership interest in one or more other corporations that are not controlled by the foreign government would not be a per se CCE. The final regulations retain this rule, so an IRC Section 892 investor can continue to use a domestic corporation to hold minority interests in USRPHCs without causing the domestic holding corporation itself to be a CCE.

Partnerships — "qualified partnership interest" exception

A partnership's commercial activities are generally attributed to its partners for IRC Section 892 purposes. To alleviate the effects of this partner attribution rule, the 2011 proposed regulations provided that income from commercial activity attributed from a partnership to a limited partner would not cause the limited partner to be considered engaged in commercial activities. The final regulations replace the "limited partner" exception with a "qualified partnership interest" (QPI) exception. The QPI exception may apply to any entity that is classified as a partnership for US federal income tax purposes, not only limited partnerships.

The final regulations contain both a general test and a safe harbor rule for determining whether a partnership interest is a QPI. Under the general test, the holder of the partnership interest must have: (1) no right to participate in the day-to-day management of the partnership, (2) no personal liability for the partnership's obligations, (3) no authority to contract for, bind, or act on behalf of the partnership, and (4) no control of the partnership (i.e., a less-than-50% interest in the profits and capital of the partnership, and no "effective control" over the partnership). Rights to monitor and protect an investor's capital investment in the partnership are not considered day-to-day management activities; the final regulations give examples of permissible monitoring activity (e.g., admission or expulsion of a partner, amending the partnership agreement, dissolution of the partnership).

An IRC Section 892 investor must meet the following requirements to fall under the safe harbor:

• Own (directly or indirectly) 5% or less of the capital or profits interests in the partnership
• Have no personal liability for the partnership's obligations
• Have no right to contract, bind or act on behalf of the partnership
• Not be a managing member or managing partner or hold a similar position in the partnership

If an IRC Section 892 investor holds more than one interest in a partnership (directly or indirectly), the interests are aggregated for purposes of determining QPI status. In tiered partnership structures, if an upper-tier partnership holds a QPI in a lower-tier partnership, the lower-tier partnership's commercial activities are not attributed upwards for determining whether any partners in the upper-tier partnership are CCEs; income from that activity, however, does not qualify for the IRC Section 892 exemption.

Applicability dates

The final regulations apply to tax years beginning on or after December 15, 2025. In general, however, taxpayers may choose to apply the final regulations to a tax year beginning before December 15, 2025, if the period of limitations on assessments is open under IRC Section 6501 and the taxpayer and all related entities consistently apply the final regulations in their entirety to the tax year and all succeeding tax years.

Proposed IRC Section 892 regulations

The proposed regulations contain significant new rules regarding (1) when an acquisition of debt by a foreign government would be considered a commercial activity, and (2) when a foreign government would be considered to have effective control of an entity engaged in commercial activities. They also provide guidance on which entities would be considered "controlled entities" of a foreign government.

Controlled entities

Under Prop. Treas. Reg. Section 1.892-2(a)(4), a controlled entity would not include an entity treated as a partnership for US federal income tax purposes. This would mean that a partnership (whether US or foreign) could not qualify for the IRC Section 892 exemption; rather, the determination of whether the exemption applies would occur at the partner level. A controlled entity also would not include any entity owned and controlled by more than one foreign sovereign.

Acquisition of debt as commercial activity

Prop. Treas. Reg. Section 1.892-4(c)(1) describes how the origination or acquisition of debt would be treated for US federal tax purposes under IRC Section 892 in an approach that is markedly different from that taken in the 2011 proposed regulations. Under the proposed regulations issued in this package, originating or acquiring debt would generally be considered a commercial activity unless the activity qualifies as an investment under one of two specific safe harbor rules, or under a general facts-and-circumstances test.

There are two safe harbor tests under which the acquisition of debt would not be considered commercial activity. Under the first safe harbor test, there would be no commercial activity if the debt is acquired in a registered public offering under the Securities Act of 1933 (as amended) as long as the acquirer is not related to the underwriter under the rules of IRC Sections 267 or 707(b) (Treasury and the IRS request comments on whether offerings registered under foreign securities laws could also qualify for this safe harbor). Under the second safe harbor test, there would be no commercial activity if (1) the debt is acquired on an established securities market and the acquirer does not acquire the debt from the issuer; (2) the acquirer does not participate in the negotiation of terms of issuance of the debt; and (3) the acquisition is not from a person that is under common management or control with the acquirer, unless that person acquired the debt as an investment and not as a commercial activity.

Under the facts-and-circumstances test, a non-exclusive list of factors would apply to determine if the acquisition of debt is a commercial activity. These factors include:

• Whether the acquirer solicited prospective borrowers, or otherwise held itself out as willing to make loans or acquire debt at or in connection with its original issuance
• Whether the acquirer materially participated in negotiating or structuring the terms of the debt
• Whether the acquirer is entitled to compensation (which could include a fee) that is not treated as interest (including original issue discount) for federal tax purposes
• The form of the debt and the issuance process, including whether the debt is a bank loan or a privately placed debt security
• The percentage of the debt issuance acquired by the acquirer relative to the percentages acquired by other purchasers
• The percentage of equity in the debt issuer held or to be held by the acquirer and the value of that equity relative to the debt acquired

• If debt is deemed to be acquired in a debt-for-debt exchange as a result of a significant modification, whether there was, at the time of acquisition of the original unmodified debt, a "reasonable expectation that the original unmodified debt would default."

The proposed regulations provide five examples of the application of these factors. In one of the examples, a controlled entity of a foreign sovereign is found to be engaged in commercial activity because it provided debt financing in a single instance to an unrelated foreign corporation (the controlled entity structured and negotiated the terms of the loan and owned no equity in the debt issuer). The example makes clear that whether the entity is treated as engaged in a trade or business for purposes of IRC Sections 162, 166 or 864(b) is not relevant for purposes of determining whether the IRC Section 892 commercial activity rule applies.

The Preamble to the proposed regulations requests comments on whether examples of other transactions should be included in final guidance, as well as on the treatment of acquisitions of distressed debt, broadly syndicated loans, revolving credit facilities or delayed-draw debt obligations.

Effective control

Under Prop. Treas. Reg. Section 1.892-5(c)(2), an entity engaged in commercial activity would be classified as a CCE for US federal income tax purposes if a foreign government has "effective control" over it. Effective control would be a facts-and-circumstances determination and would arise from any interest in the entity that directly or indirectly, either separately or in combination with other interests, results in control of an entity's operational, managerial, board-level or investor-level decisions.

Examples of interests that may confer effective control include equity and debt interests, voting rights (including the power to appoint directors or managers), contractual arrangements in or arrangements with the entity or other interest holders in it, business relationships with the entity or other interest holders in it (e.g., being a major customer or having control over a strategic natural resource used in the entity's business), regulatory authority or any relationship enabling significant influence over the entity's decision-making. Mere consultation rights (e.g., regarding managerial or investor-level decisions) would not constitute effective control. Additionally, a foreign government would automatically be deemed to have effective control if it is, or controls an entity that is, a managing partner, managing member (or equivalent under local law) of an entity.

Applicability dates

These rules are proposed to apply after final regulations are published in the Federal Register. A foreign government, however, can apply Prop. Treas. Reg. Section 1.892-2(a)(4) (which would not consider a partnership to be a controlled entity for US federal income tax purposes) to any open tax year of its directly or indirectly wholly owned entities if (i) the statute of limitations under IRC Section 6501 is still open; and (ii) the foreign government consistently uses the rule for that year and for all of the entities' following years.

Implications

These final and proposed regulations will impact foreign governments — including central banks, foreign government-sponsored pension funds, sovereign wealth funds and others — that invest in the United States through various means, including securities, real estate investment trusts, regulated investment funds, private equity funds, derivatives and debt offerings. They will also impact investment funds and asset managers whose investor base includes foreign governments and their controlled entities.

The final regulations follow the approach of the 2011 and 2022 proposed regulations fairly closely, with changes that are generally favorable to stakeholders, such as not considering a non-US corporation that is a USRPHC to be "per se" engaged in commercial activity, the expansion of the limited partnership exception of the 2011 proposed regulations to the new "QPI" exception, the retention of the minority-interest exception, and clarifications as to what constitutes inadvertent commercial activity and how to cure it.

The proposed IRC Section 892 regulations would narrow the rules for allowable debt investments that would not trigger a commercial activity/CCE determination in ways that many may find surprising, particularly because the rules unequivocally uncouple "commercial activity" from more familiar trade or business concepts found in IRC Sections 162 and 864(b).

Stakeholders should carefully consider current structures that include IRC Section 892 investors to determine whether the new rules would impact investors' CCE status, with particular attention to loan origination arrangements and debt investments that are either in place currently or planned. Stakeholders should also consider engaging with Treasury and the IRS on the impact of the proposed regulations and how they could be refined or expanded to align with foreign governments' current investment practices and the objectives of IRC Section 892 generally. Comments on the proposed regulations are due by February 13, 2026.