Tax insight

Treasury releases final and proposed regulations on taxing the income of foreign governments from investments in the United States

Insight
5 minute read
December 12, 2025

What happened?

Treasury and the IRS on December 12, 2025, issued (1) final regulations and (2) proposed regulations under Section 892 on the US taxation of income earned by foreign governments and their controlled entities from investments in the United States. 

The final regulations largely retain the structure of the 2011 and 2022 proposed regulations and, amongst other provisions:

Clarify what counts as “commercial activities” versus exempt investment activity, including an expanded inadvertent-commercial-activity exception and updates to the controlled commercial entity (CCE) rules (such as a narrower US real property holding corporation (USRPHC) per se rule including that foreign controlled entities would no longer need to track their USRPHC status).
Provide further guidance on the qualified partnership interest exception (commonly referred to as the limited partner exception) included in the 2011 proposed regulations including adopting a safe harbor for a limited partner who does not own more than 5% of the partnership’s capital and profits interest and otherwise satisfies all applicable safe harbor conditions.
Finalize a definition of “financial instrument” that expressly covers certain derivatives (including swaps, options, forwards, and futures) and refine the qualified partnership interest rules that govern when a partnership’s commercial activities are attributed to foreign government investors.

The proposed regulations would:

Provide a framework for when acquiring debt (through origination or otherwise) is treated as investment rather than commercial activity, including providing that all debt acquisitions are commercial activity except if they fall within one of the two provided safe harbors (registered offerings and certain secondary-market acquisitions) or satisfy a facts-and-circumstances test.
Elaborate on when a foreign government has “effective control” (previously referred to as “effective practical control”) of an entity (for CCE purposes), by looking to equity, voting, creditor, contractual, and regulatory rights and by treating certain managing-partner / managing-member roles as deemed effective control.

Why is it relevant? 

The final and proposed regulations matter for sovereign wealth funds, foreign central banks, foreign government pension funds, and other foreign-government–related investors investing in US securities, derivatives, real estate, and private funds. They also matter for asset managers whose investor base includes Section 892 eligible investors. The final regulations generally apply to tax years beginning on or after the date the regulations become finalized in the Federal Register. However, a taxpayer may choose to early adopt the 2025 final regulations for open pre-effective-date years if applied consistently across related entities.

The proposed regulations are more prescriptive on debt and more detailed on effective control, while largely confirming the existing Section 892 framework. The proposed rules would treat most originated loans as commercial activity with limited exceptions under two narrow safe harbors and a facts and circumstances test. This is expected to also have broader impacts on the credit investment fund industry.

Actions to consider

Reassess structures and CCE status. Taxpayers should review structures where a foreign sovereign (or its controlled entities) holds US investments—particularly domestic USRPHCs, partnerships, and private funds—to determine whether any entities are CCEs (or cease to be CCEs) under the new rules. Taxpayers should evaluate whether early adoption of the 2025 final regulations is beneficial on a consistent, group-wide basis.

Review debt positions and governance rights. Taxpayers should evaluate existing and planned US debt investments against the proposed safe harbors and the facts-and-circumstances framework, and review credit and governance documents for rights (e.g., broad veto, managing-member, or creditor protections) that could be treated as “effective control” and therefore cause entities to be CCEs.

Consider commenting. Taxpayers should consider submitting comments on the proposed regulations, including on how the debt framework and effective-control rules interact with common sovereign investment structures. Comments on the proposed regulations are expected to be due by February 13, 2026 (60 days after the scheduled Federal Register publication date of December 15, 2025).

A detailed insight into the final and proposed regulations will be separately provided.

Be sure to join our PwC Tax Readiness Webcast on Thursday, December 18 at 3pm ET for further details on these rules and other recent guidance released by the IRS and Treasury.