The One, Big, Beautiful Bill Act (OBBBA) (H.R. 1) has been making its way through Congress, having been passed by the U.S. House of Representatives and moved to the Senate, where it is currently up for review and debate. Included in the bill are new provisions with the dual aims of generating revenue and combating foreign governments’ tax regimes that may unfairly tax U.S. citizens or businesses. One of those proposed provisions is Section 899, Enforcement Remedies Against Unfair Foreign Taxes, which is intended to increase the income tax of persons and corporations from jurisdictions who levy “unfair taxes” on U.S. persons.

About Section 899

According to the proposed provision, the withholding and non-withholding taxes of the citizens and corporations (the applicable persons), of countries who impose unfair foreign taxes (discriminatory foreign countries) on U.S. citizens or corporations, will be increased by a certain amount (the applicable percentage). An unfair foreign tax includes:

• The Pillar Two undertaxed profits rule (UTPR).
• Digital services taxes (DST).
• Diverted profits taxes.
• Any extraterritorial, discriminatory or any other tax enacted with a public or stated purpose indicating the tax will be economically borne, directly or indirectly, disproportionately by U.S. persons. 

If a foreign country imposes such a tax, then the unlucky individual or corporation who is a tax resident of that discriminatory foreign country will have their U.S. taxes increased by the applicable number of percentage points. The increase is 5% in the first year and then another 5% percent in each subsequent year (capping out at 20%). For example, the 30% withholding tax imposed by Section 1445, Withholding of Tax on Dispositions of U.S. Real Property Interests, will be raised to 35% in the first year and eventually to 50%.

The statute specifically calls out the Pillar Two UTPR, digital services taxes and diverted profits taxes, which have been the focus of the global tax community for several years. It also covers “extraterritorial” and “discriminatory” taxes, both of which are broader in scope: 

• Discriminatory tax. A tax that could be imposed on a base other than net income and is not computed by permitting recovery of expenses or applies more than incidentally to income that would not be considered foreign sourced or effectively connected to a trade or business within that country.
• Extraterritorial tax. Any tax imposed by a foreign country on a corporation determined by reference to any income received by reason of being connected to such corporation through any chain of ownership, without regarding to the ownership interests of any individual, and other than by reason of direct or indirect ownership.

The statute attempts to remain narrowly tailored by providing several exceptions to the general rule, which include, among others, any tax generally imposed even if the computation of income for that tax includes payments considered to be foreign source and an income tax deemed unfair solely because it is imposed on the incomes of nonresidents by reference to income of a corporate subsidiary.

The analysis would be relatively straightforward for jurisdictions that have enacted Pillar Two’s UTPR, which includes most of Europe. Whether or not a U.S. person must actually pay the unfair tax is not immediately clear. The increase in tax is on persons from a “discriminatory country” which is defined as merely having an unfair tax on the books. No matter the final form of Section 899, its definitions and exceptions will require careful consideration by taxpayers to determine whether this new surcharge applies to them. 

Additional Provision Consideration

Section 899 is a companion to the preexisting (and long overlooked) Section 891, which was also intended to counter unfair taxation from foreign countries. Section 891 was decades ago and gave the President unilateral power to determine whether a foreign country subjected U.S. citizens or corporations to discriminatory or extraterritorial taxes, and then to proclaim U.S. tax rates be doubled on each citizen and corporation of that foreign country. There are no regulations presently issued covering Section 891 and how it should be carried out. Where Section 899 is designed as a precise strike, Section 891 is a blunt object.

While we find a surprising amount of discretion in Section 891, given that dozens of bilateral income tax treaties have been enacted into force between the statute’s passage and today, this provision would likely be overridden and still limit the federal government’s ability to tax certain income items to the treaty rates (where appropriate). 

Interaction between the Internal Revenue Code and Treaties

The interaction between federal statutes and bilateral tax agreements can be complicated.  Statutes and treaties are generally considered to be equal in authority, and courts will attempt to reconcile or harmonize any tensions between the two, trying to keep both in effect. Where there is irreconcilable conflict between statute and treaty, federal courts may employ a “later-in-time rule,” where additional weight is given to the item enacted second, or later in time, so long as there is some evidence that congress intended the subsequent statute (or treaty) would control.  The intent does not need to be from an official, prolonged pronouncement by congress; it only needs to be some (near) contemporaneous statement in the congressional record. 

But where the record is silent on congressional intent, the applicable of the later-in-time rule remains uncertain. Both the IRS and the courts have said that expressed intent – however brief – is necessary for the rule to apply. Yet Congress, in some of its pronouncements and reports, appears to disagree, maintaining that silence should not be interpreted to mean that no override was intended. Even if the legislative history of Section 899 is silent on whether Congress intended it to apply regardless of any bilateral treaty, there could still be a slight presumption in favor of an override by the application of the later-in-time rule. 

This interpretive framework works against Section 891, since it was enacted first and then the bilateral tax treaties were agreed to, with no specific reference or exemption for the statute. Courts can reasonably interpret the treaties to limit the ability of the federal government to impose the Section 891 tax, regardless of what Congress intended. Given Section 899 would be enacted after the treaties, a taxpayer could make the colorable argument that Congress’s intent was to override the treaties, or to have the new provision additions to tax be above and beyond whatever treaty rates would apply. 

Stay Tuned 

Our international tax pros are keeping a close eye on the OBBBA and its legislative changes. If Section 899 is signed into law, we will wait and see how the Courts react. We’ll keep you updated on the latest news and updates as they become available.