What the New Tax Bill Means for Cross-Border Portfolios

Our Global Head of Fixed Income Research and Public Policy Strategy Michael Zezas reads the fine print of U.S. tax legislation to understand how it might affect foreign companies operating in the U.S. and foreign investors holding U.S. debt.

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Welcome to Thoughts on the Market. I’m Michael Zezas, Global Head of Fixed Income Research and Public Policy Strategy. 

Today we're talking about a proposal tucked away in U.S. tax legislation that could impact investors in meaningful ways: Section 899.

It’s Wednesday, June 11th, at 12 pm in New York. 

So, Section 899 is basically a new rule that's part of a bigger bill that passed the House. It would give the U.S. Treasury the power to hit back with taxes on foreign companies if they think other countries are unfairly taxing U.S. businesses. And this rule could override existing tax agreements between countries, even applying to government funds and pension plans.

The immediate concern is whether foreign holdings of U.S. bonds would be taxed – something that’s not entirely clear in the draft language. Making the costs of ownership higher would affect holders of tens of trillions of U.S. securities. That includes about 25 percent of the U.S. corporate bond market. In short, the concern is that this would disincentivize ownership of U.S. bonds by overseas investors, creating extra costs or risk premium – meaning higher yields. 

The good news is that there's a decent chance the Senate will tweak or clarify Section 899. Consider the evidence that the motive of those who drafted this provision doesn’t seem to have been to tax fixed income securities. If it was, you’d expect the official estimates of how much tax revenue this provision would generate to be far higher than what was scored by Congress. Public comments by Senators seem to mirror this, signaling changes are coming. 

But while that might mitigate one acute risk associated with 899, other risks could linger. If the provision were enacted, it acts as an extra cost on foreign multinationals investing in building businesses in the U.S. That means weaker demand for U.S. dollars overall. So while this is not at the core of our FX strategy team’s thesis on why the dollar weakens further this year, it does reinforce the view. 

For European equities, our equity strategy team flags that Section 899 adds a whole new layer of worry on top of the tariff concerns everyone's been talking about. While people have been focused on European goods exports to the U.S., Section 899 could affect a much broader range of European companies doing business in America. The most vulnerable sectors include Business Services, Healthcare, Travel & Leisure, Media, and Software – basically, any European company with significant U.S. business.

The bottom line, even if modified, if section 899 stays in the bill and is enacted, there’s key ramifications for the U.S. dollar and European stocks. But pay careful attention in the coming days. The provision could be jettisoned from the Senate bill. It's still possible that it's too big of a law change to comply with the Senate’s budget reconciliation procedure, and so would get thrown out for reasons of process, rather than politics. We’ll be tracking it and keep you in the loop.

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