The Retaliatory Tax Provision Included in the One Big Beautiful Bill Act Could Have Potentially Sweeping Consequences
Client Alert | June 18, 2025
If enacted in its current form, new section 899 could significantly affect the U.S. tax landscape for a variety of U.S. and non-U.S. persons.
On May 22, 2025, the House of Representatives passed the One Big Beautiful Bill Act (the “Act”). The Act would extend or make permanent certain components of the 2017 Tax Cuts and Jobs Act[1] that under current law expire at the end of 2025. The Act would also make a number of other changes to the U.S. Internal Revenue Code (the “Code”), including adding new section 899,[2] which would impose retaliatory U.S. federal income and withholding taxes on certain governments, individuals, and entities associated with or owned by residents of foreign countries that have implemented “unfair foreign taxes.” The Senate is currently considering the Act. On June 17, 2025, the Senate Finance Committee released its markup of the Act (the “SFC Markup”).
Section 899 is based on legislation that was proposed both earlier this year and in 2023 in different forms by House Ways and Means Committee Chairman Jason Smith. It also incorporates base erosion and anti-abuse (BEAT)-related legislation proposed earlier this year by Rep. Ron Estes (R-KS) (H.R. 2423).
If enacted in its current form, section 899 could significantly affect the U.S. tax landscape for a variety of U.S. and non-U.S. persons. The most dramatic effects likely would be felt by (i) non-U.S. investors (including sovereign wealth funds) resident in certain countries, (ii) private equity funds and other investment entities, (iii) U.S. borrowers under credit agreements with standard tax “gross-up” provisions, and (iv) certain multinational enterprises and their U.S. subsidiaries.
I. Summary
A. Scope of Foreign Persons and Taxes Covered
Section 899 would apply to an array of foreign persons and their affiliates, including governments and tax residents of countries with one or more unfair foreign taxes (“applicable persons”)[3], as well as foreign corporations of which more than 50 percent of the vote or value is owned by applicable persons. The provision would also increase the tax rate and extend the application of the BEAT to corporations in which more than 50 percent of the vote or value is owned by applicable persons. Under the House version of the Act, the BEAT would apply regardless of the gross receipts and base erosion payment percentage safe harbors available under current law; under the SFC Markup, the base erosion payment percentage safe harbor would survive but would be reduced from 3 percent to 0.5 percent.[4]
The definition of “unfair foreign tax” is broad and includes any undertaxed profits rule (UTPR), digital services tax, and (under the House version of the Act) diverted profits tax, although section 899 does not define any of these taxes.[5] In addition, to the extent provided by the Secretary of the Treasury, an “unfair foreign tax” would include any extraterritorial tax,[6] discriminatory tax,[7]or other tax enacted with a public or stated purpose that the tax be economically borne, directly or indirectly, disproportionately by U.S. persons.[8] Notably, under this definition, governments and residents of countries that have adopted a UTPR as part of their legislation aimed at implementing a global minimum tax on multinational enterprises (“Pillar 2”) or that impose a digital services tax or diverted profits tax automatically would be considered “applicable persons” for purposes of section 899, without further action required from Treasury.[9] The SFC Markup specifically lists UTPRs and undertaxed profits rules as extraterritorial taxes and digital services taxes as discriminatory taxes.
B. Taxes and Tax Rates Subject to Section 899
1. General Rule for Tax Rate Increases
The following tax rates would increase by five percentage points for the first calendar year beginning after section 899 becomes applicable to the “applicable person” and then by an additional five percentage points for each calendar year thereafter (subject to a cap):
- The 30 percent rate on U.S.-source dividends, interest, rents, royalties and other fixed, determinable, annual, or period income (FDAP) of foreign individuals and corporations.
- The 21 percent rate imposed on income effectively connected with the conduct of a U.S. trade or business (ECI) of foreign corporations, including as a result of FIRPTA;
- The graduated rates applicable to FIRPTA gains and losses of individuals;
- The rates of withholding on FDAP items and payments subject to withholding under FIRPTA are similarly increased;
- The 30 percent rate on branch profits; and
- The 4 percent excise tax on foreign private foundations.
Notably, in the House version of the Act, these tax rate increases would apply based on whether a foreign country has any unfair foreign tax in place. The SFC Markup applies the rate increases solely based on extraterritorial taxes (meaning that governments and residents of countries that impose only a digital services tax or other discriminatory tax are not subject to these rate increases).
The SFC Markup also caps the rate increase at 15 percentage points over the otherwise applicable rate (whereas the House version of the Act had a 20-percentage point cap over the statutory rate).
In addition to the rate increases noted above, the House version of section 899 would also increase the BEAT tax rate for corporations to which it applies from 10 percent to 12.5 percent. The SFC Markup does not include an increase in the BEAT tax rate for section 899 purposes, but the SFC Markup would increase the BEAT rate for all taxpayers to 14 percent and make other changes (including lowering the base erosion percentage threshold to 2 percent). Both the House version and the SFC Markup would turn off the Code provisions that currently exclude certain payments from BEAT calculations, such as (i) tax benefits attributable to base erosion payments that are subject to withholding, (ii) base erosion payments for services that are eligible for use of the services cost method, and (iii) payments made at cost. In both the House version of the Act and the SFC Markup, these changes to the BEAT would apply based on whether countries have any unfair foreign tax in place (regardless of whether it is an extraterritorial or discriminatory tax).
Neither the House version nor the SFC Markup would affect the portfolio interest exemption. The SFC Markup includes a list of explicit exceptions from increased tax rates under section 899, including portfolio interest, original issue discount excluded from tax under section 881 and 871, certain other interest and interest-related dividends excluded from tax under section 881 and 871, and similar amounts specified by the Secretary of the Treasury.
2. Interaction with Treaties
Importantly, the five percentage point rate increases would also apply to lower rates established by a treaty that applies in lieu of the above statutory rates. In that case, the annual increase would start with the lower rate but would continue until the rate is 20 percentage points higher than the statutory rate that would apply if there were no treaty in place. For example, if an income tax treaty with a particular country provides that dividends may not be taxed at a rate that exceeds 15 percent, the rate would increase to 20 percent in year one, 25 percent in year two, and so on until the rate is 50 percent.
It is not clear in the House version of the Act how this rule would apply to treaties that (a) entirely cede taxing jurisdiction for an item of income to the other country (for example, a provision that U.S.-source interest may only be taxed by the other country) or (b) entirely exempt certain categories of investors, such as pension trusts. The House Budget Committee report suggests that section 899 would not affect those types of treaty exemptions. Specifically, the committee report notes that “[b]ecause the provision only increases the specified rates of tax, it does not apply to income that is explicitly excluded from the application of the specified tax…[c]ontrast certain categories of income that are subject to a reduced or zero rate of tax in lieu of the statutory rate, such as amounts that are exempted or subject to a reduced or zero rate of tax under a treaty obligation.”[10]
Importantly, the SFC Markup takes a different approach. It specifies that, other than with respect to the branch profits tax rate and the graduated rates applicable to FIRPTA gains and losses of individuals, if a tax does not apply by reason of an exemption or exception, or because the relevant category of income is taxed at a zero percent rate with respect to the applicable person (presumably due to treaty benefits), then section 899 will nevertheless impose a tax at a rate equal to the rate increase that would otherwise apply under section 899. For example, if residents of an offending foreign country (defined in the SFC Markup as a country with one or more unfair foreign taxes) otherwise benefit from a zero percent tax rate with respect to U.S.-source dividends under a tax treaty, they would be subject to a tax rate of 5 percent on such dividends in the first year that section 899 applies and a rate increasing by 5 percentage points each subsequent year, up to 15 percent in subsequent years. We note, however, that foreign governments of countries with unfair taxes that are otherwise eligible for the benefits of section 892(a) do not benefit from the limitation of tax rate to the rate increase discussed in the preceding two sentences – instead they lose their exemption under section 892(a) and are subject to applicable rate increases under section 899 (meaning such foreign governments may ultimately be subject to a 45 percent tax rate on income that would otherwise be eligible for section 892(a) benefits).
3. Other Effects
Foreign governments that otherwise are exempt from tax on FDAP under section 892(a) and subject to section 899 would not be eligible for the benefits of section 892(a) and would be subject to the increased FDAP withholding rates under both the House version of the Act and the SFC Markup. Notably, ineligibility for section 892(a) benefits under the SFC Markup applies with respect to a foreign government that enacts any unfair tax (which would include digital services taxes and other discriminatory taxes in addition to extraterritorial taxes).
4. Effective Date
Assuming Congress enacts the bill by September 30, for countries that have already enacted an “unfair foreign tax,” under the House version of the Act, the rate increases would apply beginning on January 1, 2026. For other countries, the rate increases would go into effect on the first day of the first calendar year beginning on or after (i) 90 days after the date of enactment of the bill, (ii) 180 days after the date of enactment of the applicable unfair foreign tax, or (iii) the first date that the unfair foreign tax begins to apply.[11] The SFC Markup would extend this timeline so that section 899 would not apply until at least January 1, 2027 (again, assuming Congress enacts the bill by September 30).
II. A Few Practical Take-Aways
- Fund structures. Depending on whether section 899 is enacted and in what form, fund compliance and planning would become more complex. For example, section 899 could require ongoing monitoring of the tax residence and status of investors in fund entities and their percentage interests in such entities (including feeders, holding companies, and intermediate entities), as well as monitoring of applicable withholding rates. Fund structures that currently benefit from certain investors’ U.S. federal income tax or treaty exemptions may need to be re-visited.
- Financings. Gross-up provisions, prepayment or call rights, and similar provisions in credit agreements, indentures, and other financings, as well as derivatives or hedging transactions could be implicated.
- Sovereign Wealth Funds. As currently drafted, section 899 would eliminate section 892 benefits for foreign governments that are applicable persons.
III. Next Steps
- What are people doing now and what should people be considering now? Fund managers and other affected groups are closely monitoring the situation. Managers that are forming new funds may consider structures that would mitigate the effects of section 899 for their investors, to the extent possible. Companies issuing new debt (for example, new credit agreements) are seeking to mitigate the risk of tax gross-up provisions or ensuring they have protective measures (such as ability to prepay or call debt or ability to replace lenders) in their agreements.
- What we are hearing. Section 899 is intended to provide the U.S. with negotiating leverage over other countries with respect to their UTPR, digital service taxes, or other taxes thought to discriminate against U.S. persons. Therefore, support exists among some members of the Senate for preserving a version of section 899 in the final legislation. Industry groups and individual stakeholders are working on ideas that would modify certain provisions to ameliorate the risks while allowing the provisions to still have the desired leverage over relevant countries. Interestingly, Congressional Budget Office scoring shows that section 899 will ultimately have a negative impact on governmental revenue in the long term due to its chilling effect on inbound U.S. investment.
[1] The Tax Cuts and Jobs Act is formally titled “An act to provide for reconciliation pursuant to titles II and V of the concurrent resolution on the budget for fiscal year 2018,” Pub. L. No. 115-97, 131 Stat. 2045.
[2] Unless indicated otherwise, all “section” references are to the Code or proposed additions to the Code.
[3] U.S. citizens and foreign corporations of which 50 percent or more of the vote or value is held directly or indirectly by U.S. persons are not included in the definition of “applicable person.”
[4] Constructive ownership rules apply for purposes of each of the 50 percent thresholds noted in the paragraph above.
[5] Although these concepts are not defined in section 899, the House Budget Committee Report discusses UTPRs and digital services taxes in detail. H.R. Rep. No. 119-106, at 1757-1760.
[6] An “extraterritorial tax” is a tax imposed by a foreign country on a corporation that is determined by reference to the income or profits of any other person connected to such corporation through any chain of ownership, other than by direct or indirect ownership by the corporation itself in such person.
[7] A “discriminatory tax” is a tax imposed by a foreign country that (i) applies more than incidentally to income that would not be considered sourced within, or effectively connected with a trade or business in, the foreign country applying the relevant U.S. tax rules, (ii) is imposed on a base other than net income and does not permit recovery of costs and expenses, (iii) is exclusively or predominantly applicable to nonresidents, or (iv) is not treated as an income tax under the tax laws of such foreign country or is otherwise treated by the foreign country as being outside the scope of double tax treaties.
[8] This concept is consistent with existing section 891, which allows the President of the United States to double various tax rates applicable to citizens and corporations of a foreign country if the President finds that citizens and corporations of the United States are being subject to discriminatory and exterritorial taxes in such country. The SFC Markup includes explicit coordination language to specify that the terms “extraterritorial tax” and “discriminatory” tax in section 891 have the meanings specified in section 899.
[9] For example, most European Union countries, Australia, the United Kingdom, Japan, New Zealand, and others, have implemented a UTPR, and countries such as Canada, France, Italy, Spain, Turkey, and the United Kingdom have enacted digital services or diverted profits taxes.
[10] H.R. Rep. No. 119-106, pt. 6, at 395 n.1533.
[11] Under both the House and Senate Finance Committee versions of section 899, withholding agents may rely on a list of countries published by the IRS (with a 90-day phase-in for withholding on payments to subsidiaries and trusts) and apply the rates in effect on January 1 of the year of payment. Penalties and interests for withholding agents would be waived for 2026 upon demonstrating best efforts to comply with the new withholding rates under section 899.
Gibson Dunn lawyers are available to assist in addressing any questions you may have regarding this proposed legislation. To learn more about these issues or discuss how they might impact your business, please contact the Gibson Dunn lawyer with whom you usually work, the authors, or any member of the firm’s Tax and Tax Controversy and Litigation practice groups:
Tax:
Dora Arash – Los Angeles (+1 213.229.7134, darash@gibsondunn.com)
Sandy Bhogal – Co-Chair, London (+44 20 7071 4266, sbhogal@gibsondunn.com)
Michael Q. Cannon – Dallas (+1 214.698.3232, mcannon@gibsondunn.com)
Jérôme Delaurière – Paris (+33 (0) 1 56 43 13 00, jdelauriere@gibsondunn.com)
Anne Devereaux* – Los Angeles (+1 213.229.7616, adevereaux@gibsondunn.com)
Matt Donnelly – New York/Washington, D.C. (+1 212.351.5303, mjdonnelly@gibsondunn.com)
Benjamin Fryer – London (+44 20 7071 4232, bfryer@gibsondunn.com)
Evan M. Gusler – New York (+1 212.351.2445, egusler@gibsondunn.com)
James Jennings – New York (+1 212.351.3967, jjennings@gibsondunn.com)
Kathryn A. Kelly – New York (+1 212.351.3876, kkelly@gibsondunn.com)
Brian W. Kniesly – New York (+1 212.351.2379, bkniesly@gibsondunn.com)
Pamela Lawrence Endreny – Co-Chair, New York (+1 212.351.2474, pendreny@gibsondunn.com)
Kate Long – New York (+1 212.351.3813, klong@gibsondunn.com)
Gregory V. Nelson – Houston (+1 346.718.6750, gnelson@gibsondunn.com)
Benjamin Rapp – Munich/Frankfurt (+49 89 189 33-290, brapp@gibsondunn.com)
Jennifer Sabin – New York (+1 212.351.5208, jsabin@gibsondunn.com)
Eric B. Sloan – Co-Chair, New York/Washington, D.C. (+1 212.351.2340, esloan@gibsondunn.com)
Edward S. Wei – New York (+1 212.351.3925, ewei@gibsondunn.com)
Lorna Wilson – Los Angeles (+1 213.229.7547, lwilson@gibsondunn.com)
Daniel A. Zygielbaum – Washington, D.C. (+1 202.887.3768, dzygielbaum@gibsondunn.com)
Tax Controversy and Litigation:
Saul Mezei – Washington, D.C. (+1 202.955.8693, smezei@gibsondunn.com)
Sanford W. Stark – Chair, Washington, D.C. (+1 202.887.3650, sstark@gibsondunn.com)
C. Terrell Ussing – Washington, D.C. (+1 202.887.3612, tussing@gibsondunn.com)
*Anne Devereaux, of counsel in the firm’s Los Angeles office, is admitted to practice in Washington, D.C.
© 2025 Gibson, Dunn & Crutcher LLP. All rights reserved. For contact and other information, please visit us at www.gibsondunn.com.
Attorney Advertising: These materials were prepared for general informational purposes only based on information available at the time of publication and are not intended as, do not constitute, and should not be relied upon as, legal advice or a legal opinion on any specific facts or circumstances. Gibson Dunn (and its affiliates, attorneys, and employees) shall not have any liability in connection with any use of these materials. The sharing of these materials does not establish an attorney-client relationship with the recipient and should not be relied upon as an alternative for advice from qualified counsel. Please note that facts and circumstances may vary, and prior results do not guarantee a similar outcome.