How New U.S. Tax Laws Could Alter Global Investment Strategies

On July 1, 2025, the Senate passed its revised version of “The One Big Beautiful Bill”, which was signed into law on July 4, 2025. While the final law includes key carve-outs and a delayed start date, it retains the core retaliatory mechanism.

This law will change how investment managers work with foreign investors, creating tax penalties from countries that have ‘unfair’ tax rules against U.S. businesses.

A Retaliatory Tax Tool

Section 899 imposes higher U.S. taxes on investors from “Discriminatory Foreign Countries” (DFCs) that impose extraterritorial or discriminatory taxes on U.S. businesses. The law empowers the Treasury to publish a quarterly list of DFCs, including countries with undertaxed profits rules (UTPRs), digital services taxes (DSTs), and other similar measures. Most major U.S. trading partners are potentially in scope.

For impacted investors, Section 899 increases U.S. tax rates by five percentage points each year, with a maximum increase of 15%. This applies to FDAP income (dividends and interest) and effectively connected income. It overrides treaty benefits and applies broadly to individuals, entities, and funds majority-owned by DFC persons. The scope includes offshore feeders and partnerships if they meet the 50% ownership threshold.

Key Updates vs. the House Bill

The Senate made several material adjustments to the original House version of Section 899 in response to industry pressure and market stability concerns. These changes aim to soften the economic and diplomatic impact while preserving the bill’s central objective: penalizing investors from countries that impose targeted taxes on U.S. multinationals. Changes include:

• Lowered the maximum additional tax from 20% to 15%. While still punitive, the softening reduces the most extreme scenarios (e.g., a 30% dividend withholding rising to 45% instead of 50%).
• Exempted portfolio interest and certain interest payments. This protects investments in U.S. corporate debt and Treasuries, shielding critical fixed income capital flows.
• Delayed new rules to 2027, with a safe harbor until 2026
• Focused triggering taxes on UTPRs, excluding DSTs
• Strengthened BEAT for U.S. entities linked to DFCs

These changes create new challenges for hedge fund managers who must now navigate different tax treatments for their global investors.

Implications for Hedge Fund Structures

Section 899’s final form poses significant structural considerations for hedge funds, particularly those using master-feeder structures with global investor bases. Higher taxes for investors from certain countries mean fund managers must review three key areas: how they classify entities, who their investors are, and how they handle tax withholding. Implications include:

• Offshore feeders owned by DFC investors may face higher withholding
• Fund managers need updated systems to track DFC residency and adjust rates
• Income-heavy strategies may shift to capital gains-focused investments
• DFC-based investors might seek custom classes and gross-ups
• Funds may consider DFC-specific feeders or capital reallocation

Investor Behavior and Capital Flows

The global investment landscape is already reacting to the passage of Section 899. Foreign investors reevaluate their U.S. exposure, and hedge fund allocators are recalibrating strategy preferences based on new tax dynamics. The Senate’s revisions reduced the immediate shock, but the long-term impact on cross-border capital flows remains profound. Impacts to global investments include:

• U.S. equities and real estate may lose appeal to DFC investors
• Portfolio interest exemption maintains foreign interest in U.S. debt
• Allocators may prefer strategies minimizing U.S. FDAP or ECI
• Countries affected by Section 899 might retaliate or negotiate, adding geopolitical risks

What Fund Managers Should Watch

As we look ahead to the rollout of Section 899, investment managers and allocators should begin preparing for the road ahead. While the legislation is final, many of the details, including how it will be implemented, how Treasury will apply its authority, and how investors will respond, remain uncertain.

However, it’s important to analyze the impact of the changes based on investor base and fund structuring, focus on implementation and compliance, and stay ahead of any related regulatory developments.

1. DFC List Updates: Treasury will maintain and update the list quarterly. Monitoring additions or removals is essential.
2. Guidance and Rulemaking: IRS and Treasury guidance must clarify documentation, look-through rules, and exemption mechanics.
3. Carve-Out Expansion: Treasury may broaden the list of exempt income types over time, particularly for pension and sovereign investors.
4. Investor Feedback: Managers should engage foreign investors early, understand sensitivity to tax changes, and prepare tailored communications.
5. Competitive Positioning: U.S. funds may lose ground to non-U.S. competitors. Offering non-U.S. strategies or feeders could be a differentiator.

The Bottom Line

Section 899 became law despite Senate modifications that softened some provisions. The U.S. is signaling its willingness to use tax policy as leverage in global disputes, and that shift has real implications for how hedge funds engage with foreign capital.

The delayed effective date gives managers time to prepare, but that window will close quickly. Between now and 2027, firms should assess their investor exposure, determine who might be impacted, and revisit fund documentation and withholding mechanics. The focus should be on execution, implementing operational changes, staying ahead of evolving guidance, and maintaining investor transparency.

Global fundraising dynamics are changing, and Section 899 is just one piece of the puzzle. Firms that treat this as a strategic priority, not just a compliance issue, will be better positioned to navigate the shift.

Contact Arootah today to learn more about our tailored advisory services to help you stay ahead.