IRS eases proposed sovereign wealth fund tax rules

The Internal Revenue Service and the Treasury Department released guidance providing transition relief, grandfathering protection and a delayed implementation date for proposed regulations on taxes on income generated by foreign governments whose sovereign wealth funds are investing in U.S. companies.

Last December, the Treasury and the IRS released proposed regulations under Section 892 of the Internal Revenue Code relating to taxing the income of foreign governments from investments in the U.S., as well as exemptions from taxation. The proposed regulations provided guidance for determining when an acquisition of debt by a foreign government is considered to be commercial activity, and when a foreign government has effective control of an entity engaged in commercial activities, in which case the exemption doesn't apply.

The proposed rules raised concerns among some taxpayers, so the Treasury and the IRS issued additional guidance last Friday giving them extra leeway. The new guidance offers grandfathering protection and transitional relief to foreign governments investing in the U.S.

After taking comments from stakeholders into consideration, the Treasury and the IRS have introduced a two-part approach providing both grandfathering protection and transitional relief to sovereign investors before the proposed rules become final. The new grandfathering rule proposes new applicability dates to ensure existing foreign government interests would not be subject to the final regulations.

There's also a transition period, giving foreign governments 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. 

The Treasury and the IRS said they're continuing to consider comments from interested parties on all aspects of the proposed regulations. The instructions for submitting comments are included in the new guidance.

"In response to comments on the recent proposed regulations, the IRS heard the concerns of many taxpayers and decided to provide transitional relief," said IRS CEO Frank Bisignano 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."

Several sovereign wealth funds and state-backed entities in Saudi Arabia and Qatar have reportedly invested in Trump family businesses.

According to the new guidance, as a general matter, the Treasury and the IRS did not intend for the 2025 proposed regulations, once they were finalized, to apply retroactively to existing foreign government holdings of debt and interests in entities.