The Treasury Department and the IRS issued additional guidance last month addressing the applicability dates of last year’s proposed regulations under Section 892 of the Internal Revenue Code that exempt foreign governments, including sovereign wealth funds, from tax on certain income derived from passive U.S. investments.
The additional guidance also provides grandfathering protection and transitional relief to foreign governments investing in the U.S.
“President Trump’s economic policies continue to attract trillions of dollars in investment into the United States. Treasury and the IRS conducted thorough reviews of taxpayer and stakeholder comments on proposed technical U.S. tax rules, which informed the release of additional guidance to provide certainty on the treatment of current investments and transitional relief to sovereign investors,” Treasury Secretary Scott Bessent said in a statement on May 29. “As final regulations continue to develop, we will evaluate feedback to ensure that they strengthen the American economy, uphold established market practices, and maintain a stable environment for existing and future sovereign wealth fund investment.”
Last December, the Treasury Department and the IRS issued proposed regulations under Section 892, clarifying when an acquisition of debt by a foreign government is commercial activity and when a foreign government has effective control of an entity engaged in commercial activities, in which cases the exemption doesn’t apply.
The government received 18 comment letters on the 2025 proposed regulations, according to Big Four firm EY. Some provisions raised concerns because they could significantly restrict a foreign government’s ability to qualify for the Section 892 exemption on investment income from certain common investment structures or transactions, if finalized as proposed.
EY explains:
Regarding whether the acquisition of debt is considered commercial activity, the 2025 proposed regulations list a non-exclusive set of factors, including whether the acquirer solicited the borrower, materially participated in negotiating or structuring the debt, held an equity interest in the issuer, or acquired the debt at original issuance. Commenters expressed concern that the 2025 proposed regulations do not articulate how those factors are to be weighed or how they collectively distinguish an investment return on capital from a return attributable to lending activity or services. Commenters emphasized that, absent a stated governing principle, the test provides limited guidance on how to analyze similar fact patterns and creates uncertainty for debt acquisitions that fall outside the safe harbors.
Commenters also expressed concern that the definition of “effective control” in the 2025 proposed regulations could encompass minority investor protections that are commonly included to protect investment value, such as veto rights and consent rights. This could result in a finding that a foreign government has effective control over an entity even under arrangements that would not involve day-to-day management or operational control of the entity.
After taking stakeholder comments into consideration, the Treasury Department and the IRS introduced a two-part approach that provides both grandfathering protection and transitional relief to sovereign investors before these proposed rules become final:
- Grandfathering rule: It proposes new applicability dates to ensure that existing foreign government interests wouldn’t be subject to the final regulations.
- Transition period: A foreign government has at least 90 days after the publication date or until the start of the first taxable year after the publication date to transition to the final regulations.
“In response to comments on the recent proposed regulations, the IRS heard the concerns of many taxpayers and decided to provide transitional relief,” IRS CEO Frank Bisignano said in a statement. “With these changes, the IRS aims to preserve established market practices, drive domestic economic growth, and support current and future sovereign wealth fund investment in the United States.”
The Treasury Department and the IRS said they will continue to consider comments from interested parties on all aspects of the proposed regulations.
Instructions for submitting comments are included in last month’s guidance.
Photo caption: Treasury Secretary Scott Bessent (Scott Bessent/Facebook)
Sign in to get access to this free resource, and all of our whitepapers and reports.
Download this content today!
Register Now Already registered? Click here to Log In
