On December 12, 2025, the Department of the Treasury and the Internal Revenue Service (IRS) released final and proposed regulations under section 892 of the Internal Revenue Code, providing an exemption from U.S. federal income tax for certain income earned by foreign governments and their controlled entities from U.S. investments, including from U.S. stocks, bonds, and other financial instruments. Other types of income – referred to as income derived from the conduct of a commercial activity or received by, from, or through a controlled commercial entity (a CCE) – are not exempt under section 892. The final regulations largely adopt and refine prior proposed rules issued in 2011 and 2022, while the proposed regulations introduce new frameworks for determining whether debt investments constitute commercial activity and determining whether commercial entities are subject to "effective control" by a foreign government. 

Consistent with prior proposed rules, the final regulations provide a broad definition of "commercial activity," providing that commercial activities for section 892 purposes are broader than the trade-or-business inquiry under sections 162 or 864. Notably, the final regulations preserve the exceptions from the 2022 proposed regulations regarding the United States Real Property Holding Corporation (USRPHC) rule. The final regulations also finalize (with modifications) the "limited partner" exception from the 2011 proposed regulations, under a new "qualified partnership interest" label. Finally, the regulations adopt the inadvertent-commercial-activity exception from the 2011 proposed regulations, with modifications. As finalized, the determination of whether a failure to avoid inadvertent commercial activities is reasonable is a facts-and-circumstances determination, which must be supported by new procedural requirements (due diligence, written policies, and other operational procedures), and the cure period for discontinuing such inadvertent commercial activities is extended from 120 days to 180 days. 

The proposed regulations introduce two significant new frameworks for determining whether an entity investing in debt is engaged in commercial activity and whether a foreign government possesses "effective control" over an entity engaged in commercial activity (thus rendering that controlled entity a CCE). First, the proposed regulations provide detailed rules regarding when the acquisition of debt qualifies as a commercial activity, rather than as an "investment" for which the section 892 exemption may apply. Under these rules, an acquisition of debt would be treated as a commercial activity unless it falls within safe harbors for certain registered offerings and secondary market acquisitions or satisfies a facts-and-circumstances test. The factors considered in the latter determination include the acquirer's (i) level of involvement in origination, negotiation, and structuring of the loan, including whether it held itself out as willing to make loans or otherwise acquire debt in connection with its original issuance, (ii) compensation beyond interest, (iii) equity in the issuer relative to the debt, and (iv) expectations regarding default or modification. The proposed regulations include numerous examples illustrating these factors. These rules, if finalized, could materially affect private-credit structures and direct-lending activities involving section 892 investors. Second, the proposed regulations provide a detailed definition of "effective control," which generally relies on a facts-and-circumstances test. The regulations include a per-se rule treating a foreign government as possessing effective control of an entity if that foreign government or another entity it controls is a managing partner or managing member of the tested entity. 

The final regulations generally apply to taxable years beginning on or after December 15, 2025, with taxpayers permitted to apply them to prior open taxable years subject to consistency requirements. The proposed regulations would apply prospectively once finalized. A government official recently indicated that forthcoming guidance will clarify that the new rules in the proposed regulations will not apply to existing investments. 

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