Implications of Proposed New Section 899 for CLOs and Related Products

The One Big Beautiful Bill Act, a budget reconciliation bill, passed the United States House of Representatives vote on May 22, 2025 and is currently under Senate consideration. The bill, if enacted, would make sweeping changes to the tax law, including by adding a new section 899 to the Internal Revenue Code. Section 899, if enacted in its current form, could have a material impact on CLOs and other credit products. An overview and summary of the bill can be found here.

Overview and Uncertainty

Section 899 would generally increase the U.S. tax rates applicable to any government of, or any individual or corporation resident in, any foreign country (a “discriminatory foreign country”) that has one or more taxes that are deemed unfair or discriminatory in respect of U.S. persons, i.e., an “unfair foreign tax.” Stated more colloquially, section 899 would increase the U.S. tax rates for persons resident in foreign countries with tax regimes that are unfavorable for U.S. companies.

The Cayman Islands, Jersey, Bermuda and other tax advantageous jurisdictions where SPVs are ordinarily formed are not expected to qualify as a discriminatory foreign country. Many of the EU countries, however, including Ireland and Luxembourg, are expected to qualify as such. The provision would increase the applicable tax rates for “passive” income (i.e., U.S. source interest and dividends, and other fixed or determinable, annual or periodical income, which is generally taxed at the flat rate of 30% on a gross basis) and “active” income (i.e., income effectively connected to a U.S. trade or business, or, “ECI”, which is generally taxed at the rates normally applicable to U.S. taxpayers on a net basis). Where section 899 applies, the applicable tax rate would increase from the rate otherwise applicable (e.g., 30%) by 5% increments for each year the unfair foreign tax continues to be imposed (subject to a cap equal to a 20% increase from the statutory rate determined without regard to any exemption or reduction). Thus, an item of income that would otherwise subject to 30% U.S. withholding tax for a non-U.S. person that is resident in a discriminatory foreign country could potentially be subject to U.S. tax up to a rate of 50%, unless the foreign country repeals the unfair foreign tax.

There is some uncertainty as to whether section 899 would apply to various items of income that are currently exempt from, or subject to a reduced rate of, U.S. tax, e.g., portfolio interest (which otherwise would be exempt from U.S. tax under the “portfolio interest exemption”) or income that is subject to a reduced or zero rate of tax under an income tax treaty. Reports from the House Budget Committee and the Joint Committee on Taxation suggest that while section 899 would not apply to portfolio interest, it would apply to income otherwise subject to a reduced or zero rate under an income tax treaty. Such application, however, could conceivably result in a violation of an income tax treaty on the part of the United States vis-à-vis the treaty counterparty, and any such violation could have diplomatic ramifications. For this reason, it is possible that the final version of the provision would clarify that reduced tax rates under an income tax treaty are not subject to an increase under section 899.

Implications for CLOs and Related Products

The version of section 899 that passed the House vote could have material implications for CLOs and credit-related products, most notably, middle market loan CLOs (including European middle market loan CLOs) (“MM CLOs”) and asset-based lending facilities (“ABLs”). Generally, interest payments on MM CLO Notes, or to lenders under ABLs, are in most cases not subject to U.S. withholding taxes since lenders are typically able to qualify for the portfolio interest exemption or a reduced or zero rate of tax under an applicable income tax treaty. Any increase in the tax rate on interest could potentially result in tax redemptions or replacement of lenders (i.e., “yank-a-bank”), or, to the extent applicable, tax indemnifications and gross-ups. CLOs ordinarily do not require the issuer to indemnify or gross up investors for withholding taxes, whereas credit agreement commonly require borrowers to indemnify or gross up lenders for withholding taxes arising from a change in law.

The version of Section 899 that passed the House vote does not include a grandfathering clause. Consequently, any credit agreement entered into before the enactment of Section 899 may require the borrower to indemnify or gross up any affected lender. For credit agreements entered into after the enactment of Section 899 but before the enactment of the unfair foreign tax, there may be interpretive uncertainty regarding whether any additional tax imposed should be considered an "indemnified tax." This uncertainty arises because the additional tax could be viewed as imposed under a law effective as of the execution date (i.e., Section 899), rather than the unfair foreign tax, which merely triggers Section 899. Clarifications on this point may be necessary when negotiating credit agreements post-enactment.

Please feel free to contact a member of Dechert's Global Tax Team if you would like to discuss how the proposed changes may affect you.