House and Senate Bills Propose New Retaliatory Tax Measure on Certain Payments to Foreign Investors and Foreign Owned U.S. Corporations

A new retaliatory tax measure targeting taxpayers in countries with purportedly “unfair foreign taxes” would be added to the Internal Revenue Code as new section 899 under the budget reconciliation bill passed by the House of Representatives on May 22, 2025, and now retained in similar form in the version of the bill released by the Senate Finance Committee on June 16, 2025. If enacted, it would have broad effect. Unfair foreign taxes in both versions would include, at a minimum, digital services taxes and the undertaxed profits rule under the OECD’s Pillar 2 regime (the “UTPR”). Residents of foreign countries and their subsidiaries with unfair foreign taxes (or, in the Senate Finance version, a subset of unfair foreign taxes referred to as “extraterritorial taxes”) would suffer incrementally increasing U.S. federal income and withholding tax rates. In addition, U.S. taxpayers owned by residents of so-called “discriminatory foreign countries” would be within a substantially expanded scope of the Base Erosion and Anti-Abuse Tax (BEAT).[1]

The cornerstone of proposed section 899 under both the House and Senate Finance versions of the bill is the concept of an “unfair foreign tax.” Under the House version, the term would encompass any digital services tax, diverted profits tax, UTPR and, “to the extent provided by the Secretary [of the Treasury], an extraterritorial tax, discriminatory tax, or any other tax enacted with a public or stated purpose indicating the tax will be economically borne, directly or indirectly, disproportionately by United States persons.”[2] The House version includes broad definitions of “extraterritorial tax” and “discriminatory tax” to guide the assessment of any such foreign taxes by the Treasury. Although there are small drafting differences, the Senate Finance version employs the same broad definitions of “extraterritorial tax” and “discriminatory tax,” with the modification that any UTPR or digital services tax will be included as a category of extraterritorial tax or discriminatory tax, respectively. In addition, under the Senate Finance version, a diverted profits tax is not listed as a per se unfair foreign tax.

Application to U.S. Source Income of Foreign Applicable Persons

In its current form, the section 899 proposal would operate primarily by increasing certain tax rates for the following (each an “applicable person”):

1. any foreign corporation that is a tax resident of a discriminatory foreign country, other than a foreign corporation at least 50 percent owned (by vote or value) by U.S. persons;
2. any foreign corporation (other than a publicly held corporation) that is more than 50 percent owned directly or indirectly through foreign entities by applicable persons (by vote or value);
3. any other entity (including branches) identified by the IRS with respect to a discriminatory foreign country;[3]
4. any individual (other than a U.S. citizen or resident) who is a tax resident of a discriminatory foreign country;
5. any trust for which the majority of beneficial interests are held directly or indirectly by applicable persons; and
6. any private foundation created or organized in a discriminatory foreign country; and
7. any government of a discriminatory foreign country. [4]

Section 899 would increase the applicable federal income and withholding tax rates that otherwise apply under current law on certain income earned by such applicable persons. In both cases, the increase would be imposed in annual, five-percentage-point increments. However, significant differences exist between the two versions in most other aspects.

Under the House version, the increase would be imposed in annual, five-percentage-point increments for each year an unfair foreign tax is in effect, up to a maximum rate of 20 percentage points above the regular statutory rate. The increases would apply to the rate otherwise applicable under current law – either the U.S. statutory rates or the relevant treaty rates. The ultimate maximum rate of 50 percent would be the same. For example, the maximum withholding rate on dividends would be 50 percent regardless of whether the recipient applicable person is otherwise eligible for a reduced rate of withholding tax under a tax treaty.

By contrast, under the Senate Finance version of the measure, the increased tax rates would apply only where an extraterritorial tax (e.g., a UTPR) is in effect, and only up to a maximum rate of 15 percentage points above the applicable statutory or treaty rate. For example, where the recipient applicable person is otherwise eligible for a 10-percent rate of withholding tax on dividends under a tax treaty, the maximum withholding rate on dividends would be 25 percent.

The following categories of income would be subject to the retaliatory tax increase:

1. Certain payments of dividends, interest, royalties, services income, and fixed or determinable annual or periodical income (“FDAPI”) of foreign corporations and nonresident individuals;
2. Income of a foreign corporation that is effectively connected with a U.S. trade or business (“ECI”) or attributable to a U.S. permanent establishment (“PE”), as well as any “deemed dividend” from such operations under the U.S. branch profits tax;
3. ECI of individuals arising from gains on U.S. real property interests under the Foreign Investment in Real Property Tax Act (“FIRPTA”); and
4. U.S.-source investment income of foreign private foundations.

Where the U.S. tax on one of these categories of income is collected by withholding, the rates of which are generally increased by a corresponding amount. 

The legislative history of the House bill states that the increase in tax rates is not intended to apply to portfolio interest, on which “no tax is imposed” under U.S. domestic law.[5] By contrast, amounts that are simply “exempted or subject to a reduced or zero rate of tax under a treaty obligation” are intended to be subject to increased rates under the House proposal. Additionally, a footnote in the legislative history to the House bill explains that section 899 is not intended to override the tax-exempt status of organizations recognized under section 501(c). Based on this language, a question has arisen whether, for example, a foreign corporation which would be subject to tax on ECI under U.S. domestic law, but which is protected from such taxation because it does not have a U.S. PE under an applicable tax treaty, would lose that protection.

The Senate Finance version takes a somewhat different approach, with potentially meaningful consequences. The measure specifies that the rate increases apply if a tax otherwise applicable to a person is not imposed “by reason of an exemption or exception, or is imposed at a rate of tax equal to zero.”[6]The Senate Finance version then separately exempts certain items of income from the proposed rate increases, including short-term original issue discount, portfolio interest, certain other interest and interest-related dividends, and similar amounts to be specified by the Treasury Department. There is no reference to section 501(c).These differences in drafting raise the issue of whether the Senate Finance version applies to foreign tax-exempt entities, and it appears less likely to allow foreign corporations that are resident in targeted foreign countries to retain their PE protection under an applicable tax treaty.

Application to Certain Foreign-Owned U.S. Corporations: BEAT

Section 899 also would substantially expand the scope of entities subject to the BEAT and increase those taxpayers’ BEAT liability.

Under the House version of the bill, any non-public domestic corporation that is more than 50 percent owned by applicable persons would be automatically deemed to meet the BEAT’s gross receipts and base erosion percentage tests. In addition, the corporation would be subject to an enhanced 12.5 percent BEAT rate instead of the current 10.1 percent BEAT rate that would be extended under the bill.[7]

The Senate Finance version retains the general base erosion percentage threshold but lowers it to 0.5 percent from 2 percent. Also, while the Senate Finance version of section 899 does not include a specific increased BEAT rate, the Senate bill would separately increase the BEAT rate to 14 percent for all taxpayers.

Under both versions of proposed section 899, an applicable corporation would also be denied certain credits and the reduction to BEAT liability for payments already subject to U.S. withholding tax.In addition, the services cost method exception would be eliminated, and certain payments capitalized into cost of goods sold would become subject to BEAT.

Effective Dates

Under the House version of the bill, the income and withholding tax rate increases and the modifications to the application of the BEAT are proposed to apply to taxable years beginning after the later of (i) 90 days after the date of enactment of the U.S. legislation, (ii) 180 days after the date of enactment of the unfair foreign tax that causes the country in question to be treated as a discriminatory foreign country, or (iii) the first date that the unfair foreign tax of such country begins to apply. The delayed effective date is intended to “allow time for negotiations” and provide “discretion for the Secretary of the Treasury to expand or narrow the definition of unfair taxes.”[8] The increased rates would cease to apply to taxable years following the last date on which the discriminatory foreign country imposes an unfair foreign tax. Thus, for countries with existing taxes targeted by the regime, enactment of the measure before October 4, 2025 would generally cause proposed section 899 to apply on January 1, 2026 for calendar-year taxpayers.

The Senate Finance version provides a further delay to the effective date: The proposed changes would apply to taxable years beginning after the later of (i) one year after the enactment of the U.S. legislation, (ii) 180 days after the enactment of the unfair foreign tax, or (iii) the first date the unfair foreign tax applies.Thus, the effective date of the regime under the Senate Finance version generally would be deferred until January 1, 2027.

Background and Outlook

Much of this provision, including the tax rate increases, is modeled after similar legislation first introduced in 2023, and then again earlier this legislative session by House Ways and Means Committee Chairman Jason Smith.The expanded BEAT components are modeled after legislation previously introduced by Representative Ron Estes. While none of these bills gained traction in the prior session of Congress due to the Democrat-controlled Senate and White House, the bills were popular among House Republicans.

The inclusion of proposed section 899 in both the House and Senate Finance versions of the pending tax legislation increases the likelihood that some version of this provision will ultimately be included in the final legislation, but its inclusion in the final version of the legislation is not a foregone conclusion as the proposal presents various practical, policy and legal challenges, as well as raising substantial administrability issues for withholding agents who would be required to implement the new, variable withholding tax rates. However, one factor favoring its eventual inclusion in final legislation is that proposed section 899 is estimated to raise significant revenue in a bill otherwise containing significant tax cuts, and which must ultimately be within the revenue limitations imposed on the reconciliation process. The Joint Committee on Taxation has estimated the House and Senate Finance versions of the provision to raise, approximately $116 billion and $52 billion, respectively, from 2026 through 2034.

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