02 June 2026 Proposed IRC Section 892 regulations would modify applicability dates of 2025 proposed regulations and providing transition period
On May 29, 2026, the Treasury Department and IRS issued proposed regulations under IRC Section 892 (CC-00349656-26) and a withdrawal announcement (the May 2026 proposed regulations) modifying the proposed IRC Section 892 regulations issued on December 15, 2025 (REG-101952-24) (the 2025 proposed regulations) (see EY's prior Tax Alert on the 2025 proposed regulations). The May 2026 proposed regulations provide important relief to foreign governments and sovereign wealth funds by providing new applicability dates so that existing foreign government holdings will not be subject to the new final IRC Section 892 regulations on debt acquisition or effective control when those final regulations are ultimately issued (the forthcoming final IRC Section 892 regulations). The May 2026 proposed regulations also provide a transition period for the rules on debt acquisition and effective control. The transition period is at least 90 days from the publication date of the final IRC Section 892 regulations, or the start of the first tax year after their publication date, whichever is later. Foreign government holdings acquired before the end of the transition period, or under a binding commitment entered before the end of the transition period, would not be subject to the forthcoming final IRC Section 892 regulations on effective control or debt acquisition. Instead, the current IRC Section 892 rules on those issues would apply to these holdings. 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 (i) from "commercial activity," (ii) received by or from a "controlled commercial entity" (CCE), which is 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 (iii) from a disposition of an interest in a CCE. On December 15, 2025, the Treasury Department and IRS issued the 2025 proposed regulations, as well as certain final regulations (TD 10042), under IRC Section 892. The 2025 proposed regulations provide guidance for determining whether an acquisition of debt is a commercial activity, as well as whether a foreign government has effective control of an entity, and introduced significant changes to the rules for debt investments and the determination of CCEs (Prop. Treas. Reg. Sections 1.892-4(c)(1)(ii) and 1.892-5(c)(2)). In particular, the 2025 proposed regulations would generally treat the origination or acquisition of debt as a commercial activity unless it:
Separately, the 2025 proposed regulations would broaden the concept of effective control. Prop. Treas. Reg. Section 1.892-5(c)(2)(i) defines "effective control" for purposes of determining whether an entity is a CCE by reference to control over operational, managerial, board-level or investor-level decisions, based on all facts and circumstances. These concepts are illustrated through examples addressing various governance rights. The 2025 proposed regulations were proposed to apply to tax years beginning on or after the date when the regulations are finalized. The government received 18 comment letters on the 2025 proposed regulations, many of which focused on the proposed rules governing when the acquisition of debt could be considered commercial activity, as well as when a foreign government could be considered to have effective control over an entity. These provisions provoked much controversy because they could significantly restrict a foreign government's ability to qualify for the IRC Section 892 exemption on investment income from certain common investment structures or transactions, if finalized as proposed. Regarding whether the acquisition of debt is considered commercial activity, the 2025 proposed regulations list a non-exclusive set of factors, including whether the acquirer solicited the borrower, materially participated in negotiating or structuring the debt, held an equity interest in the issuer, or acquired the debt at original issuance. Commenters expressed concern that the 2025 proposed regulations do not articulate how those factors are to be weighed or how they collectively distinguish an investment return on capital from a return attributable to lending activity or services. Commenters emphasized that, absent a stated governing principle, the test provides limited guidance on how to analyze similar fact patterns and creates uncertainty for debt acquisitions that fall outside the safe harbors. Commenters also expressed concern that the definition of "effective control" in the 2025 proposed regulations could encompass minority investor protections that are commonly included to protect investment value, such as veto rights and consent rights. This could result in a finding that a foreign government has effective control over an entity even under arrangements that would not involve day-to-day management or operational control of the entity. The May 2026 proposed regulations would withdraw Prop. Treas. Reg. Sections 1.892-4(d) and 1.892-5(e) as issued in December 2025 and propose new applicability dates for the proposed regulations so that the forthcoming final IRC Section 892 regulations on debt acquisition and effective control would not apply to certain existing foreign government holdings. They also provide a transition period regarding the rules on debt acquisition and effective control of at least 90 days from the publication date of the final IRC Section 892 regulations, or the start of the first tax year after their publication date, whichever is later. The forthcoming final IRC Section 892 regulations on effective control or debt acquisition would not apply to foreign government holdings acquired before the end of the transition period, or under a binding commitment entered before the end of the transition period. Instead, the current IRC Section 892 rules on those issues would apply to these holdings. Specifically, under Prop. Treas. Reg. Section 1.892-4(d)(4), the current IRC Section 892 rules would continue to apply to determine whether debt acquired before the end of the transition period or under a binding commitment entered before the end of the transition period is commercial activity and whether income received from that debt in future periods is derived from commercial activity. The Preamble makes clear that the acquisition of a debt, not the mere holding of it, is potential commercial activity; as such, a debt acquirer is not engaged in commercial activity in the years following a debt investment's acquisition solely because the acquirer holds the debt in those subsequent years. The Preamble also clarifies that a debt investment that was acquired in a prior year and held in the current year would not cause other debt acquisitions in the current year to be treated as commercial activity. Similarly, under Prop. Treas. Reg. Section 1.892-5(e)(2)(ii), the effective control rules in the forthcoming final IRC Section 892 regulations would not apply to a foreign government's existing interests in an entity unless the foreign government acquired, after the transition period, new interests in an entity that by themselves would give the foreign government effective control under the final regulations. The effective control rules would similarly not apply to acquisitions of interests in an entity under a binding commitment entered before the end of the transition period. The May 2026 proposed regulations only address the proposed applicability dates of the 2025 proposed regulations, and do not address any of the substantive issues raised in comments submitted to the government. The Preamble to the May 2026 proposed regulations indicates that the government is considering how to reflect comments received on these proposed rules "by taking into account established market practices and the general policy to support current and future sovereign wealth fund investment in the United States." While the May 2026 proposed regulations are narrow in scope, they provide broad relief to the market in terms of reassuring stakeholders that current investment structures and those entered during the transition period would continue to be subject to existing IRC Section 892 guidance, and not forthcoming final IRC Section 892 regulations on effective control and debt acquisition. They also send an important signal that Treasury and the IRS will likely continue to be receptive to stakeholder concerns about preserving market stability for foreign governments and sovereign wealth funds while work on finalizing the IRC Section 892 guidance continues.
Document ID: 2026-1176 | ||||||
