Changing Foreign Government Income Rules Risks Blurring a Line

The IRS and Treasury Department’s effort to modernize the tax treatment of sovereign wealth funds under Section 892 of the Internal Revenue Code is both constructive and necessary.

The modern statute was enacted as part of the Tax Reform Act of 1986 and amended modestly over the next 40 years. Capital markets have changed dramatically, and the need for regulatory clarity is essential to maintaining confidence, predictability, and fairness, particularly where foreign capital is involved.

However, in the process of updating rules designed for a very different era, policymakers must not sweep fundamentally different forms of investor participation into the same regulatory framework. The central challenge raised by the proposed rules is how to distinguish legitimate investor stewardship from effective control of a business.

It’s important to be clear about what this debate is about. This isn’t an argument against regulation, nor a reflexive industry objection to reform. Section 892 needs revisiting as it relates to the rapid growth of private credit, direct lending, and co-investment strategies, which barely existed when the statute was enacted.

When sovereign investors exert operating control over businesses, influence employment or pricing, or shape credit availability at scale, the tax code should absolutely respond.

The difficulty arises when the line between stewardship and control is drawn too narrowly. In many investment structures, particularly those involving large, long-term capital commitments, investors require meaningful protection to ensure that their capital is deployed consistently with their business plans. These protections are about preserving value, not running a business.

Foreign capital invested in the US economy has helped enable outcomes that policymakers favor, including housing supply, infrastructure development, research facilities, and place-based economic growth. These investments often are measured in decades, not quarters, and involve hundreds of millions or billions of dollars committed to a single platform or portfolio.

In that context, it’s neither unusual nor inappropriate for an investor to seek assurances that fundamental decisions won’t be made unilaterally or outside the agreed scope of the investment.

The risk is most acute during periods of uncertainty, such as the development phase of a project or during market stress, where governance isn’t just expected but essential. Development is capital intensive and uncertain by nature, with potential changes in budgets, construction timelines, and market conditions.

Responsible investors, whether domestic or foreign, must exercise fiduciary oversight, manage risk, and ensure disciplined capital deployment. This oversight falls under stewardship, not control.

This distinction is critical. Control, under Section 892’s amendments, was meant to capture situations where a foreign government is operating a business and earning returns that resemble active business income.

Stewardship is different. It involves consent rights, veto rights, and other customary minority protections that prevent actions outside the ordinary course but don’t permit the investor to direct day-to-day operations, appoint management unilaterally, or determine business strategy.

When customary investor protections are treated as evidence of control, the result is confusion for investors, sponsors, and regulators alike. Market participants cannot easily determine when normal governance crosses a regulatory line, even though the underlying economic activity has not changed.

This uncertainty isn’t inevitable. A workable framework can distinguish between investors who protect the value of their capital and investors who actually control a business. That distinction should turn on who manages day-to-day operations, whether governance rights are shared or exclusive, and whether investor protections are designed to prevent extraordinary actions rather than direct ordinary business decisions.

Section 892 was designed to distinguish between passive investment and effective control. That line must be drawn in a way that reflects how modern capital markets function. A sovereign investor approving a budget, consenting to a major asset sale, or protecting itself against material deviations from an agreed plan isn’t directing an operating business. Treating such actions as control risks expanding the statute beyond its original intent.

The predictable outcome would be a reduction in foreign capital flowing into complex, long-term investments that require patient capital and stable governance. Required returns would rise, projects would become more expensive or unviable, and some capital would move elsewhere.

While investment in the US wouldn’t disappear, it could migrate into less transparent structures that increase friction and reduce clarity, an outcome that serves neither regulators nor markets.

None of this requires the IRS or Treasury to abandon its modernization effort. Modest refinements could preserve the integrity of Section 892 while avoiding unintended harm. Clear guidance that distinguishes minority investor protections from effective control, paired with practical safe harbors that reflect customary governance structures, would provide certainty without weakening enforcement.

Getting this right matters. The US faces acute housing shortages, aging infrastructure, and an urgent need for long-term investment in innovation and place-based growth. Rules that blur the line between stewardship and control risk discouraging the very capital that supports those priorities.

Regulatory certainty attracts capital. Misclassification drives it away. With careful calibration, the IRS and Treasury can modernize Section 892 while ensuring that legitimate investor stewardship is treated as what it is and not mistaken for control.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law, Bloomberg Tax, and Bloomberg Government, or its owners.

Author Information

Josh Parker is CEO of Ancora and chairman of The Real Estate Roundtable’s Tax Policy Advisory Committee.

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