Trump Administration and Congressional Republicans consider tax and withholding increases in response to Pillar Two and DSTs

With the new administration, the US tax landscape has been active in the last three months, with tariffs being the main focus of attention for many.  Aside from tariffs, there have been other tax developments as well and we wanted to bring to your attention some of the potentially most relevant updates.

Budget resolution clears the way to United States tax reform

On April 10, 2025, the House Republicans narrowly approved by a vote of 216 – 214 a revised budget resolution passed by the Senate the previous week.  Budget reconciliation is a special procedure of the United States two chambers of Congress – Senate  and House of Representatives – that is designed to expedite the passage of certain legislation, especially in situations where bipartisan support is not expected. 

This step clears the way to the next stage of the expected tax reform process, however there are still a lot of hurdles and challenges along the way.  Without going into detail about the technicalities of both chambers’ reconciliation instructions and spending limitations, we have highlighted the main proposals and likely tax developments with focus on the proposed discriminatory or extraterritorial taxes. 

In addition, the main focus of the current Administration is to extend certain of the tax provisions implemented by the Tax Cuts and Jobs Act of 2017 (TCJA) – this is the bill that introduced the big US tax reform from the first Trump presidency and introduced tax concepts such as BEAT, GILTI, FDII and many other tax changes. While the corporate tax provisions of the TCJA act were mainly made permanent, many of the individual tax provisions were set to expire by end of 2025. Among the expected extenders are - reduced income tax rates for individuals, increased exemptions for the individual AMT and the estate and gift tax, the doubled child tax credit, the increased standard deduction, increase limitation of state and local tax deduction and the 20% deduction for passthrough business income, among others. 

Tax and withholding increases considered in response to Pillar Two and DSTs

The Trump administration and House Republican tax writers are separately considering US tax increases on investors from countries that impose undertaxed profits rules (UTPRs), digital services taxes (DSTs), or other “discriminatory or extraterritorial taxes” on US citizens or corporations. The two main proposals are described shortly below and both efforts appear focused on deterring UTPRs and DSTs by threatening to impose tax burdens on inbound foreign investment. 

Proposed Defending American Jobs and Investment Act

In January this year, House Ways and Means Committee Chairman Jason Smith introduced a tax bill, titled the “Defending American Jobs and Investment Act”, which would add a special provision aimed at increasing taxes to individuals and corporations from tax jurisdictions imposing extraterritorial or discriminatory taxes on US taxpayers. A few observations on the proposed Section 899:

• The tax authorities will propose and maintain a list of foreign countries that impose one or more extraterritorial or discriminatory taxes (defined below), to the appropriate committees of Congress within 90 days of the enactment.  Starting 181 days after a country appears on the list, the tax rates for citizens and corporations created and organized in the respective country will increase in five-percentage-point increments for each year a country remains on the list, for up to four years.

• Extraterritorial tax is defined as a tax imposed by a foreign country on a corporation that is determined by reference to any income or profits received by any persons by reason of such person being connected to such corporation through any chain of ownership, determined without regard to the ownership interests of any individual, and other than by reason of such corporation having a direct or indirect ownership interest in such person.

• Discriminatory tax is defined as a tax imposed by a foreign country if such tax either:
  • Applies to items of income that would not be considered from sources within the foreign country (applying tax code source-rule principles);
  • Is imposed on a base other than net income and is not computed by permitting recovery of costs and expenses;
  • Is exclusively or predominantly applicable, in practice or by its terms, to individuals not resident in the country and corporations or partnerships organized outside the country; or
  • Is not treated as an income tax under the laws of such foreign country or is otherwise treated by such foreign country as outside the scope of any double tax agreements that are in force between such foreign country and one or more jurisdictions.

• The proposed rules would apply to withholding taxes as well – increasing the withholding rates gradually from 35% to 50% on dividends, interest, royalties and other FDAP type payments applicable to foreign individuals and corporations and may not withhold at lower treaty rates. Transferees of US real property interests (USRPIs) would have to withhold at rates of 20% to 35% on proceeds of a USRPI disposition by an applicable person.

• The proposed rules expressly address the interaction with tax treaties by effectively “turning off” the relevant regulations allowing for claim of reduced withholding under an income tax treaty on payments to applicable persons. 

• Proposed section 899 might possibly have its largest impact on citizens of and corporations organized in countries that enact a UTPR or a DST, but do not have a US income tax treaty.

Proposed Unfair Tax Prevention Act (UTPA)

Another proposal is making its way to the House Ways and Means Committee, the so called, Unfair Tax Prevention Act (UTPA), which is aimed at tightening the US base erosion and anti-avoidance tax (BEAT) rules for companies based in jurisdictions that impose an undertaxed profits rule (UTPR) or other exterritorial tax on US multinationals. This proposed bill is aiming at the US subsidiaries of such foreign jurisdictions. According to a high-level summary of proposed legislation, the UTPA would:

• Define “foreign-owned exterritorial tax regime entities” (FETR entities) as foreign-controlled entities connected with entities operating in jurisdictions with extraterritorial taxes aimed at US business operations, including the UTPR surtax;

• Strengthen the BEAT rules by eliminating the 3 percent base erosion percentage floor and the $500 million gross receipts test for FETR entities;

• Revoke the ability of FETR entities to disregard certain service payments and payments subject to withholding taxes, and treat 50 percent of cost of goods sold as a base erosion tax benefit; and

• Accelerate the scheduled BEAT rate increase and tax credit changes for FETR entities.

Section 891

One of the first steps of the Trump administration was to introduce a memorandum which instructed the Treasury Secretary to investigate whether any foreign country subjects US citizens or corporations to discriminatory or extraterritorial taxes under the existing Section 891 of the Internal Revenue Code.  Section 891 is a long-standing code section providing that, upon a determination by the President that US citizens or US corporation are being subjected to discriminatory or extraterritorial taxes imposed by a foreign country, would double the applicable US tax rates applicable to the citizens or corporations of such foreign country.  Section 891 was enacted in 1934 and it has never been invoked by a president of the United States. As it has never been implemented, this code section raises many questions and carries a lot of limitations, such as lack of specific definition for what constitutes discriminatory and extraterritorial taxes, does not address withholding taxes and predates every US tax treaty currently in force. The proposed Section 899, described in short above attempts to address many of these limitations. 

More developments are expected in the coming months on the US legislation front – we will keep you updated as developments unfold.

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