House Bill’s Proposed Section 899: Targeting Unfair Foreign Taxes 

The proposed Section 899 rules would impose retaliatory tax measures, including additional tax payments for foreign individuals (other than a citizen or resident of the U.S.), foreign governmental entities and foreign entities resident in countries deemed to have “unfair foreign taxes” (e.g., Digital Service Taxes and other extraterritorial or discriminatory taxes such as the OECD’s Pillar Two Under-Taxed Profits Rule). The proposed rules would generally impose higher withholding rates, increased tax rates on effectively connected income, increased branch profits tax rate and modifications to the Base Erosion Anti-Abuse Tax (“BEAT”). An exemption from the application of Section 899 is provided for U.S.-owned foreign companies, where U.S. owners hold more than 50% of the combined voting power or value of the stock of a foreign company.

Under both the Senate and House proposals, the U.S. Federal income tax rate in relation to effectively connected income and the branch profits tax, would increase by 5% each year if the foreign entity or individual is located in a country deemed to have unfair foreign taxes. The House bill would provide for an increase of the federal income tax rate on effectively connected income from 21%, not to exceed 41% over four years, while the Senate bill would increase the 21% tax rate, not to exceed 36% over three years. In addition, the U.S. branch profits tax rate would increase from 30%, to potentially 50% (under the House bill) or 45% (under the Senate bill).

Section 899 would also impose increased withholding tax rates on FDAP income when payments are made to residents of a jurisdiction with unfair foreign taxes. The withholding tax rate applied would increase by 5% annually, up to 20% under the House bill (only up to 15% under the Senate bill).The Joint Committee on Taxation report (JCX-21-25) made clear that the increased rates will be added onto the agreed upon rate provided in a U.S. tax treaty. For example, if the general withholding rate on dividends (and other FDAP income) of 30% applies; the 5% would be applied annually and the maximum general withholding rate would be either 45% to 50% depending on which version of the bill passes. However, if the U.S.-Foreign country taxtreaty provides a rate of 5% on dividends (and other FDAP income) the House bill would increase the rate to 25% over a four-year period, and the Senate bill would increase the rate to 20% over a three year period.

Section 899 would also modify the BEAT rules for non-publicly held U.S. corporations that are more than 50% owned by residents located in an unfair foreign tax system. It would remove the gross receipts and base erosion percentage thresholds that generally need to be met for taxpayers to be subject to the BEAT. Currently, the BEAT is a corporate minimum tax designed to prevent large multinational corporations from reducing their U.S. tax liability through deductible payments with related parties (such as interest, royalties and service fees). It applies to corporations with average annual gross receipts of at least $500 million and a base erosion percentage of 3% or more, ensuring they pay a minimum level of tax on modified taxable income that includes these base erosion payments. The proposed modification would remove the $500 million gross receipts and the base erosion percentage requirement, and instead make BEAT applicable to all BEAT payments made by a non-publicly held U.S. corporation to a resident country with “unfair foreign taxes”. In addition, the BEAT rate for applicable persons would also increase from 10% to 12.5% under the House bill, and 14% under the Senate bill.

We will continue to monitor the status of these rules as the bill moves through Congress.

Author: Calvin Yung | [email protected]