New Section 892 Proposed Regulations: Transition Relief and Grandfathering

On May 29, 2026, the U.S. Department of the Treasury (Treasury Department) and the Internal Revenue Service (IRS) issued proposed Treasury Regulations (CC-00349656-26; RIN 1545-BR10) that partially withdraw the applicability date provisions of the Debt Acquisition Rule (as defined below) and the Effective Control Rule (as defined below) from the December 12, 2025 proposed Treasury Regulations. They also clarified the “grandfathering” provisions related to the same (New Proposed Regulations) as a response to commenters’ concerns that the absence of transitional relief could force 892 Investors (as defined below) to restructure existing holdings, particularly with respect to debt acquisitions and entity interests, without adequate time to adapt. For a detailed discussion on the December 2025 proposed Treasury Regulations (2025 Proposed Regulations), please see our prior OnPoint: IRS Issues New Regulations Impacting Foreign Government Investments in the United States.¹

Under current law, foreign governments (including “controlled entities” of foreign governments) are generally exempt from U.S. withholding taxes in respect of their investment activities under Section 892 of the Internal Revenue Code of 1986, as amended (an 892 Investor). However, this exemption does not apply to income derived from commercial activities or in respect of income derived from a “controlled commercial entity” (CCE) by such 892 Investors.

The 2025 Proposed Regulations would, once finalized and effective, among other rules, provide new guidance on two key issues: (1) when an acquisition of debt by an 892 Investor is considered to be a commercial activity (Debt Acquisition Rule), and (2) when an 892 Investor has “effective control” of an entity engaged in commercial activities, thus causing the entity to become a CCE (Effective Control Rule). The 2025 Proposed Regulations do not contain a “grandfathering” or similar rule for existing investments, which created a significant uncertainty for 892 Investors. The New Proposed Regulations respond to these concerns, establishing a transition period before the Debt Acquisition Rule and the Effective Control Rule in the final regulations apply and providing relative certainty around grandfathering.

This guidance addresses applicability dates only. A broader overhaul of the December 2025 substantive rules (including the Debt Acquisition and Effective Control) is also underway. With respect to the substantive rules, the preamble states that Treasury and the IRS are “taking into account established market practices and the general policy to support current and future sovereign wealth fund investment in the United States.”

Debt Acquisition Rule

Transition Relief

For the Debt Acquisition Rule, the New Proposed Regulations provide that the new rules would apply only to acquisitions of debt on or after the date that is the later of: (i) the first day of the acquirer’s first taxable year beginning on or after the date of publication of the final rule, or (ii) 90 days after the date of publication of the final rule.

Grandfathering

Under the New Proposed Regulations, if debt is acquired before the end of the transition period or pursuant to a binding commitment entered into before the end of the transition period, the existing rules applicable before the final regulations are published would continue to apply to determine whether that acquisition is commercial activity, and, accordingly, whether income received from that debt in future periods is derived from commercial activity.

Because it is the acquisition of debt (not the mere holding of debt) that is potentially treated as commercial activity for purposes of Section 892, a debt acquirer is not engaged in commercial activity in taxable years following the taxable year of the acquisition of the debt solely by reason of holding the debt in the subsequent taxable years. Furthermore, a debt that was acquired in a previous year and held in the current year does not cause other debt acquisitions in the current year to be treated as commercial activity.

This clarification addresses an important uncertainty: the New Proposed Regulations confirm that pre-transition debt holdings neither “taint” otherwise exempt income in future taxable years nor affect the characterization of other debt acquisitions made in those same years.

Effective Control Rule

Transition Relief

For the Effective Control Rule, the New Proposed Regulations similarly provide that it would apply only on or after the later of: (i) the first day of the 892 Investor’s first taxable year beginning on or after the publication date of the final regulations, or (ii) 90 days after the publication date of the final regulations.

Grandfathering

The Effective Control Rule in the final regulations would not apply to an 892 Investor’s existing interests in an entity unless the 892 Investor acquires, after the transition period, one or more new interests in the entity that, in the aggregate, would provide the 892 Investor with effective control under the final regulations (but without taking into account Previously Acquired Interests, i.e., (i) interests in the same entity acquired before the later of the applicable transition dates, or (ii) interests acquired pursuant to a binding commitment entered into before the end of the transition period) (such non-Previously Acquired interests, New Controlling Interests). Unless and until this occurs, whether that entity is a CCE would be determined under the existing rules applicable before the final regulations are published, which will take into account all interests, regardless of when acquired.

Open Questions on Grandfathering

While the New Proposed Regulations offer some welcome comfort to 892 Investors for their investment activity prior to when the 2025 Proposed Regulations are finalized, there remains some uncertainty about the application of these grandfathering rules to certain common investment scenarios.

Debt Acquisition Grandfathering

• Significant modification of debt. The New Proposed Regulations do not address whether a “significant modification” for federal income tax purposes of pre-transition grandfathered debt would be treated as a “new” acquisition subject to the final regulations, or whether the grandfathering framework would continue to apply.
• Revolving credit facilities and delayed-draw term loans (DDTLs). The New Proposed Regulations likewise leave an open question whether each draw under a revolving facility or delayed draw under a DDTL constitutes a separate “acquisition” of debt, or whether all draws under a pre-transition commitment fall within the binding commitment carve-out.

Effective Control Grandfathering

• What constitutes a “new interest.” It is unclear whether a recapitalization of an existing investment, a modification to existing governing documents, a change in the economic terms of an existing equity interest or any other similar changes would be treated as the acquisition of a “new interest” capable of triggering the loss of grandfathering.