Proposed Surcharge on Foreign Taxpayers (Section 899)

In the reconciliation bill advancing the President’s legislative agenda, House Republicans have included a tax surcharge on individuals and entities from countries that impose an “unfair foreign tax” on US individuals and companies. The proposal could have significant effects on bilateral tax treaties, the level of foreign investment in the US, and demand for US Treasuries.

• Section 899 of the House reconciliation bill includes an additional tax on individuals and entities from foreign countries that impose an “unfair foreign tax,” defined in the bill to include an undertaxed profits rule (UTPR) and a digital services tax (DST).
• The Section 899 tax would be an additional 5% tax on individuals and entities from countries the Secretary of the Treasury lists as “discriminatory foreign countries,” escalating by 5 percentage points annually up to 20% on top of regular US taxes due.
• The proposed tax both serves as revenue to offset the cost of the reconciliation bill and attempts to codify the intent behind the Administration’s recent executive actions regarding tax treaties and foreign investment – but it could also be viewed as a negotiating tactic, which would mitigate any deficit reduction if successful.
• Section 899 arguably violates bilateral tax treaties with the US and could have significant implications for foreign investment into the US because of the higher costs imposed on foreign individuals and companies as well as demand for US Treasuries if the tax is applied to interest on US government debt held by foreign persons and governments.

House Republicans Propose Section 899 Tax

As part of the budget reconciliation process Republicans are using to advance the President’s legislative agenda, House Republicans have proposed a tax on taxpayers connected to foreign jurisdictions that the Secretary of the Treasury deems impose an “unfair foreign tax” on US individuals and companies. Section 899 of the bill defines an “unfair foreign tax” as a UTPR, DST, diverted profits tax, or any other tax deemed extraterritorial or discriminatory with a public or stated purpose indicating the tax will be economically borne (directly or indirectly) by US persons. However, perhaps responding to earlier criticisms, the bill explicitly excludes a value added tax from the list of “unfair foreign taxes.”

Under the provision, the Treasury Secretary would be required to list the “discriminatory foreign countries” that impose these “unfair” foreign taxes, and the proposed tax applies to foreign governments; individuals who are not US citizens or residents; and foreign corporations, private foundations, trusts, and partnerships and branches. For individuals and entities from the countries on the list, the additional tax would start at 5% and increase by 5 percentage points annually up to 20%. The tax would also apply to certain passive investment income including dividends and interest and profits earned by foreign companies with US operations. Finally, the bill includes a temporary safe harbor provision for withholding agents preventing the imposition of penalties until January 1, 2027, if they demonstrate best efforts at compliance.

Motivations Behind Section 899 Tax

The proposed Section 899 tax has several motivations. The most immediate goal is to provide deficit reductions to offset the costs of extending the expiring provisions of the Tax Cuts and Jobs Act and other spending measures in the reconciliation bill. The Joint Committee on Taxation (JCT) estimates that the proposed Section 899 tax provision would raise $116 billion in revenue between 2025 and 2034. As context, the Congressional Budget Office (CBO) released its latest projections of the budgetary impact of the House version of the reconciliation bill, estimating that the entire bill will increase deficits by $2.4 trillion between 2025 and 2034. (CBO did not provide a separate estimate of the budgetary impact of the section but simply uses JCT’s numbers in its later calculation of the effects on the deficit.)

More broadly, the Section 899 tax attempts to codify the intent of several initiatives from the Administration regarding tax treaties and foreign investment. The first executive action directed the withdrawal of the US from implementing the Organization for Economic Cooperation and Development (OECD) global minimum tax framework. The OECD’s framework consists of two pillars: Pillar One adjusts where multinational enterprises pay taxes to align with the source of a company’s revenue (i.e., where a company’s goods or services are consumed as opposed to manufactured or the location of a multinational company’s headquarters); Pillar Two introduces a 15% global minimum tax along with provisions regarding taxable income, deductions, and a “top-up tax.” Pillar Two includes the UTPR, which limits a multinational enterprise’s ability to take deductions to the extent it is not subject to the global minimum 15% tax rate. Thirty countries have implemented the UTPR, including many European Union countries, Japan, New Zealand, South Korea, and the UK. While the Biden Administration helped negotiate and strongly supported the agreement, Republicans in Congress strongly opposed implementation and would not have enacted the statutory changes necessary for the US to adopt the framework. (In addition, some Republicans have complained that the framework does not sufficiently take into account US efforts at base erosion, such as the 10.5% US Global Intangible Low-Tax Income (GILTI) tax added in the 2017 tax bill.)

Foreign Digital Services Taxes

The second executive action concerns DSTs that disproportionately affect US tech companies. In February, the President signed a Memorandum contending that “foreign governments have increasingly exerted extraterritorial authority over American companies, particularly in the technology sector,” with a particular focus on DSTs “that could cost American companies billions and that foreign government officials openly admit are designed to plunder American companies.” Countries such as Canada, France, India, Indonesia, Italy, Spain, Turkey, and the UK have implemented a DST, and others are considering it or are awaiting implementation. The Memorandum suggests a potential reopening of investigations under Section 301 of the Trade Act of 1974 that the first Trump Administration brought against DSTs in France, Austria, Italy, Spain, Turkey, and the UK; opens the way for investigations of DSTs in any other country; and suggests convening a panel under the United States-Mexico-Canada Agreement (USMCA) to investigate Canada’s DST.

Investment Policy

The third executive action is a Memorandum describing inbound and outbound investment under an “America First Investment Policy.” The Memorandum highlights the benefits of a generally open investment policy and proposes “fast track” review for some investments from allied and partner countries. However, it contains very strong language on China and uses a broad definition of “critical infrastructure” in which Chinese companies will not be able to invest. The Memorandum orders a review of the 1984 US-China bilateral tax treaty, blaming that and the grant of Most Favored Nation status to China for “the deindustrialization of the United States and the technological modernization of the PRC military.”

Impact on Bilateral Tax Treaties

Besides directly threatening sanctions on US financial firms, the Memorandum continues a series of statements the Administration has made on the need to review bilateral tax treaties, which are important to promote investment by avoiding double taxation. Granting Most Favored Nation status was a condition of China’s entry into the World Trade Organization (WTO); withdrawal of that status would arguably put the US in violation of its WTO obligations and would not be received well by China.

Given this context, the Section 899 tax provision raises concerns regarding the application of the many bilateral tax treaties the US has signed with foreign countries, particularly China and countries that have implemented UTPR or a DST. (Courts could rule that enactment of the Section 899 provision is a “subsequent enactment” that could effectively override the bilateral tax treaty.) Referring to countries that have implemented UTPR and DSTs, House Committee on Ways and Means Chairman Jason Smith (R-MO) said, “This is a way to help put them in check, so that they understand that if they do that to our businesses, there will be consequences for their actions. Hopefully it'll never take an effect.” This last comment contradicts the immediate goal of providing deficit reductions from fully implementing this additional tax.

Potential Implications for Foreign Investment and Treasuries

There are significant risks that the Section 899 tax provision would reduce foreign investment in the US given the higher tax rate foreign individuals and companies would face if they happen to be from a country the Treasury Secretary deems to be a “discriminatory foreign country.” Of particular concern is whether the interest on US Treasuries that goes to foreigners in “discriminatory foreign countries” would be taxed, affecting the demand for US government debt. A footnote in the House Budget Committee’s report on the reconciliation bill states that the provision “does not apply to portfolio interest” that typically includes interest on US Treasuries. However, it is uncertain whether the statutory language in the bill itself is sufficiently clear on this matter to assuage foreign investors (or US courts ruling on the provision).

Conclusion

As with other aspects of the House’s version of the reconciliation bill, the Senate will likely amend the bill to satisfy Republican Senators concerned about the bill’s deficit impact and Republican Senators worried about cuts to Medicaid and the social safety net and the phase out of clean energy tax credits. Because of the speed of negotiations and votes in the House, some Republican Members of Congress are also just now fully digesting the contents of the more than 1,000-page reconciliation bill, raising issues with certain provisions of which they were not fully aware before casting their votes. Provisions such as Section 899 will receive more scrutiny as businesses, analysts, and tax attorneys comb through the reconciliation bill and assess its implications.