Tax

On December 12, 2025, the Internal Revenue Service (“IRS”) released final regulations under Section 892 of the Internal Revenue Code (TD 10042), together with proposed regulations (REG-101952-24), addressing when a foreign government or their controlled entities is treated as engaged in commercial activity (and certain other matters relating to the application of Section 892).

The final regulations – which focus on certain matters relating to the definition of commercial activity and controlled commercial entities (“CCEs”), and the treatment of certain partnership investments – largely retain the structure of proposed regulations promulgated in 2011 and 2022 with modifications. The proposed regulations provide further clarification focusing on when debt investments constitute “commercial activity” and the circumstances in which a foreign government is treated as having “effective control” of an entity engaged in commercial activities for CCEs qualification purposes.

Background on Section 892

Section 892 generally provides an exemption from Federal income tax for certain U.S.-source investment income earned by foreign governments, including income from stocks, bonds, and other securities, as well as interest on U.S. bank deposits. The exemption does not apply to income that is:

• Derived from commercial activity (whether within or outside the United States), or
• Earned by, or received from, a CCE, defined as an entity engaged in commercial activity that is either majority-owned by a foreign government (by value or voting interest) or otherwise subject to its effective control.

Highlights of the Final Regulations

The final regulations largely retain the approach of the 2011 and 2022 proposed regulations, with targeted modifications. Key aspects are highlighted below.

 Clarification of “Commercial Activities” and Updates to the CCE Rules

• The final regulations clarify the distinction between commercial activities, which disqualify income from Section 892 exemption, and exempt investment activities.
• Commercial activities continue to be defined broadly as activities ordinarily conducted for the current or future production of income or gain, regardless of whether the activity would constitute a trade or business under other provisions of the Code. At the same time, the regulations reaffirm that investment activities generally are not commercial activities.
• The final regulations also expand and formalize the inadvertent commercial activity exception, under which an entity will not be treated as engaged in commercial activity if (i) the failure to avoid the activity was reasonable, (ii) the activity is timely cured (generally within 180 days of discovery), and (iii) appropriate records are maintained. A safe harbor applies where assets or income attributable to inadvertent commercial activity do not exceed 5% of the entity’s total assets or income.
• The final regulations update the CCE rules, including narrowing the U.S. real property holding corporation (“USRPHC”) per se rule to apply only to domestic corporations. As a result, foreign controlled entities are no longer treated as CCEs solely because of their status as USRPHCs, and foreign government investors are no longer required to track USRPHC status solely for Section 892 purposes.

Investment Exception and Financial Instruments

• The final regulations clarify that investment activities are not commercial activities. The investment exception includes investments in stocks, bonds, other securities, loans, partnership equity interests, financial instruments, net leases of real property, holding of real property not producing income, and bank deposits. However, the proposed regulations (described below) adding further clarity as to when lending activities would constitute commercial activity.
• The regulations further confirm that investing and trading in financial instruments (including derivatives) for a foreign government’s own account do not constitute commercial activity, provided the foreign government is not acting as a dealer and the expected return represents a return on capital.

Qualified Partnership Interest Exception

• The final regulations provide additional guidance regarding the qualified partnership interest (“QPI”) exception (commonly referred to as the limited partner exception). Under this exception, a foreign government investor generally will not be treated as engaged in a partnership’s commercial activities provided that the investor does not: (i) have personal liability for partnership obligations, (ii) have right to enter into contracts or act on behalf of the partnership, (iii) participate in the management or conduct of the partnership’s business, or otherwise exercise effective control over the partnership, and (iv) owns no more than 5% (directly or indirectly) of the partnership’s capital and profits interests.
• In addition, the final regulations (i) clarify that an upper-tier partnership holding a QPI in a lower-tier partnership is not attributed the lower-tier partnership’s commercial activities and (ii) provide further guidance on multi-tier partnership structures.

Highlights of the Proposed Regulations

Acquisition of Debt

• The proposed rules would treat all acquisitions of debt as commercial activity by default, unless the transaction qualifies as an investment under one of two safe harbors or under a facts-and-circumstances analysis demonstrating that the expected return is solely a return on capital. The term “debt” would mean an obligation treated as debt for federal tax purposes.
• The safe harbors include:
  • Registered public offerings: acquisitions of debt issued in Securities Act registered offerings, provided that the underwriters are not related to the acquirer; and
  • Qualified secondary market acquisitions: purchases on an established securities market, provided that the acquirer is not purchasing from the issuer or negotiating the terms of the debt and does not acquire the debt from a person under common management or control.
• Debt acquisitions outside these safe harbors will require careful analysis based on all facts and circumstances to avoid commercial activity characterization. The proposed regulations include a non-exclusive list of relevant factors and illustrate the application of those factors through examples.

Effective Control and CCE

• The proposed regulations adopt a broad functional standard for determining effective control. A foreign government is treated as having effective control of an entity if it can influence or control operational, management, board-level, or investor-level decisions.
• No minimum ownership threshold would apply. Effective control may arise from minority equity stakes combined with governance or veto rights, creditor protections that constrain budgets or capital decisions, contractual arrangements, or regulatory authority.
• The proposed regulations provide practical examples illustrating circumstances in which effective control does or does not exist.

Clarification Regarding Partnerships

• The proposed regulations clarify that partnerships are not “controlled entities” for purposes of Section 892. Treasury and the IRS take the view that the controlled-entity concept is intended to address whether a separate taxable entity qualifies for the exemption, and partnerships are generally not subject to entity-level U.S. income tax.

Timing and Next Steps

The proposed regulations are open to public comments and requests for a public hearing for a 60-day period. If finalized, they would apply to taxable years beginning on or after the date of publication.

Weil Observation The final regulations provide clarity in several core areas of Section 892, particularly with respect to debt investments, and ownership of USRPHCs. At the same time, the proposed Section 892 regulations reflect a policy shift by presuming commercial activity for many debt acquisitions. For example, in the Final Regulations, Treasury rejected a “number of loans annually” safe harbor for determining when lending activities rise to the level of commercial activity. The regulations would require foreign government investors to reassess existing investment, lending, and governance arrangements (and their own internal investment guidelines).