In the news, it’s another whirlwind week and I’m not really commenting on most of the things the Trump administration does because frankly, I can’t track everything. Even though I restricted my focus on trade and finance-related issues, it seemed like a big deal in the tariff announcement a few days later. Even though the alleged bombshell revelation last week, the federal court ruled that all taxes were illegal, briefly causing stock markets to soar in the future, another court blocked the ruling 24 hours later, causing the market to fall back to Earth.
But there is a news that cheers up my ears, an obscure part of the big beauty bill the government is trying to push through through Congress’ efforts, called Section 899.
The “A Big Beauty Act” includes the biggest changes in the U.S. tax treatment for foreign capital under Section 899 for decades
The U.S. Foreign Tax Act exudes uneasiness on Wall Street at CNBC.com
What is Section 899?
Section 899 is a new addition to the Income Tax Code that this Act will create as passed in its current form, which is its working principle.
Article 899 is to deal with the U.S. government’s worries about countries that implement digital service tax or DST. Typically, digital services such as streaming services are free off-road boundaries as no physical goods pass customs. DST is a sales tax, an surcharge for digital services offered nationwide, and is very annoyed by it because it allows foreign governments to tax large U.S. tech companies like Google and Netflix.
The U.S. government considers these taxes discriminatory and marks any country that implements them as “discriminatory foreign countries”, but contains a large number of countries. Canada has DST, the United Kingdom, France, Spain, Italy, India and Turkey as well. Many countries in the EU are also implementing DST, so this list will become very large, very fast.
To punish these discriminatory countries, Section 899 adds new withholding taxes to citizens of these countries who invest in U.S. assets. This includes stocks, bonds, ETFs and real estate.
This tax will serve as a structure for withholding tax, meaning it can be deducted from any dividend, interest or rent before being received by foreign investors. Withholding is 5% in the first year and then upgrades 5% per year until it reaches up to 20%.
How it will hurt foreign investors
Now, it is important not to overreact before anyone panics. This is still a draft legislation that passed the Congress Chamber. It is still debated in the Senate, it may not pass at all, and it may pass with the change. Two major questions about how this new tax will work remain.
The first question is: How does this interact with international tax agreements? Even before this change, foreign investors’ default “statutory” withholding rates were all 30%, but international tax agreements lowered the issue. For example, the Canada-U.S. Tax Treaty sets the dividend deduction rate and interest rate to 15%, and completely eliminates funds held in retirement accounts. If Article 899 covers the tax treaty, the withholding rate may be increased from 15% to 50% nosebleeding levels (30% statutory + up to 20% increase).
The second question is: Is this higher tax eligible to be called a foreign tax credit? In Canada, taxes paid to foreign governments can be deducted based on your internal tax bill, so if you have other income, it may leave the total tax bill unchanged as you can offset it by reducing the internal tax bill.
Now that both questions are not sure, we need to know what these issues are before we can start figuring out which portfolio changes may be needed.
How it hurts the United States
Following foreign investors seems like free money to the U.S. government, but you have to remember that foreign investors won’t have Invest in the United States. Only the UK and Canada have only $1T of US national debt, and if 50% of the interest in these countries is taken away, it is absolutely meaningless to have U.S. bonds in these countries. Given that the U.S. just lost its final AAA credit rating due to Moody’s, U.S. Treasuries are not considered as investments that they used to be rock fixed in the past due to the surge in Treasuries.
Even though it is still believed that the U.S. government is unlikely to default on its debts, Section 899 effectively confiscates a portion of the interest, making it less attractive to own them. And if a large number of investors start selling the U.S. Treasury immediately, this will lead to higher U.S. bond yields, which will make all U.S. products more expensive, from collateral to credit cards. This will also increase the interest rates paid by the U.S. government, and because Treasury bonds are high, this becomes a big problem as interest payments increasingly bear the government’s budget.
in conclusion
The investment landscape is constantly changing this year, and it seems that new changes will be made to tariffs or tax rules every few days. This is enough to get your head spinning, and a huge challenge is filtering out the signal from the noise.
Article 899 is a very significant change that will fundamentally change the rules that have managed cross-border tax plans for decades. It’s still early, but if the bill becomes law, we’ll let everyone know what changes will happen, and if anything, we’ll respond to our investments on this blog, stay tuned!
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