Introduction
As the end of the year approaches, world leaders are trying to reach an agreement on a global tax framework to address U.S. concern over discriminatory taxation. The Organization for Economic Cooperation and Development’s (OECD) two-pillar tax agreement, which includes a global minimum tax under Pillar Two, remains a contentious issue nearly five years after its first draft was released.
The U.S. is now considering a slate of options to respond to elements of Pillar Two that unfairly target American firms amid ongoing implementation of Pillar Two around the world. One option is to implement what is essentially a “revenge tax.” This was briefly included in the One Big Beautiful Bill Act (OBBBA) as Section 899 of the tax code before being removed when an agreement was reached between the U.S. and G7 to provide Pillar Two relief for U.S. companies.
How does it work?
Section 899 would have incrementally increased the tax rate on taxpayers based in jurisdictions that have imposed taxes deemed unfair or discriminatory on U.S.-based taxpayers. The tax increase begins at a rate of 5% and increases by that amount annually until reaching a cap of 20%. As included in the bill, Section 899 would also modify the base erosion and anti-abuse tax (BEAT). Known as ‘super BEAT,’ this provision would expand the number of U.S. subsidiaries of foreign companies that are subject to BEAT and increase their BEAT liability.
This provision was modified slightly in the Senate version of the bill prior to being removed from the final version. The Senate provision would have capped the tax increase at 15% rather than 20% while explicitly carving out portfolio interest. It also narrowed the scope of the super BEAT provision.
Should Section 899 be revived, the exact tax rate increase and modifications to BEAT may change. Lawmakers will need to balance the desire for an effective retaliatory tool with potential economic consequences of the provision if it were to be implemented.
Another element that could change is which discriminatory or extraterritorial taxes imposed by other jurisdictions would trigger the tax. The House version of Section 899 included digital services taxes, while a later version focused on Pillar Two’s undertaxed profits rule. Finally, legislators could change the process by which a tax is declared discriminatory and the timing to begin and stop the retaliatory tax hike.
What are its predecessors?
Section 899 as included in OBBBA resembles two current pieces of legislation: the Defending American Jobs and Investment Act (H.R. 591) introduced by Ways and Means Committee Chairman Jason Smith (R-MO) and the Unfair Tax Prevention Act (H.R. 2423) introduced by Representative Ron Estes (R-KS). Smith’s bill would increase the U.S. tax rate on citizens and corporations in offending jurisdictions by 5% per year, capped at 20%. Estes’s bill would modify BEAT, making it more stringent for firms based in offending jurisdictions.
Retaliatory taxes also have historical precedent with the enactment of Section 891 in 1934. This is a legacy item in the tax code that has never been invoked, although its codification successfully deterred discriminatory taxation of U.S. firms by France at the time of enactment.
If invoked, Section 891 would double the tax rate of citizens and companies in jurisdictions that the President deems have imposed discriminatory or extraterritorial taxes on U.S. citizens or companies. The tax collected would be capped at 80% of the citizen or corporation’s taxable income and double taxation would end in the tax year after the President declares a jurisdiction to have ended its discriminatory or extraterritorial tax.
President Trump has asked the Secretary of the Treasury, the Secretary of Commerce, and the United States Trade Representative to investigate the applicability of Section 891 to taxes currently being implemented by other countries.
Why does it matter now?
The U.S. may reconsider a retaliatory tax should other countries target it with certain tax elements of Pillar Two. Before signing OBBBA into law, the U.S. decided to drop Section 899 from the bill due to an agreement with G7 countries to explore a side-by-side system exempting U.S. companies from Pillar Two’s global minimum tax, instead allowing them to operate under existing U.S. tax law. OBBBA made changes to the U.S. global minimum tax created by the Tax Cuts and Jobs Act of 2017 to align it more closely with Pillar Two expectations, making it suitable for a side-by-side system.
The Department of the Treasury and some lawmakers want to see progress on a side-by-side approach by the end of the year. Concerns are growing as to whether quick implementation of a side-by-side agreement is practical given the number of countries involved, especially ones that have already implemented elements of Pillar Two, and the years of delay in agreeing to Pillar Two as it stands now. Exempting U.S. companies from Pillar Two would require agreement among OECD countries, unanimous agreement among European Union countries on a new Pillar Two directive, and new administrative guidance from the OECD.
Resolving the issue is also critical for businesses that deserve clarity. Pillar Two is extremely complex, with companies reporting that most of their costs will be from compliance with Pillar Two rather than an additional tax liability. Uncertainty around sporadic global implementation of such complex rules, combined with the expectation of high compliance costs, complicates business decision-making. Meanwhile, businesses must also monitor developments from the United Nations on a separate global tax framework.
Conclusion
Section 899’s “revenge tax” may not be law, but it will continue to be part of the global tax discourse so long as American companies face the threat of unfair or discriminatory taxation by other countries. It has already proven to be a successful tool of negotiation that the U.S. plans to lean on if negotiations stall with the OECD.
The U.S. implemented the world’s first global minimum tax in 2017, which the OECD failed to consider during development of Pillar Two despite concerns from U.S. leaders. An effective side-by-side agreement would allow companies to operate under current U.S. international tax law and would preclude potentially disruptive retaliatory measures. Moving forward, the international community should be cautious in implementing further global tax measures that are unduly punitive and costly.