Trump Tax Bill's Retaliatory Clause May Raise U.S. Borrowing Costs by 20%

The 899th clause in the Trump tax and spending bill, intended to retaliate against digital service taxes imposed by certain countries, has sparked concerns among legal experts. They caution that this "retaliatory tax" could inadvertently burden American borrowers with higher borrowing costs. The clause targets countries that have implemented digital service taxes or other tax rules deemed unfair by the United States. Investors and companies from these countries will face gradually increasing tax rates on income derived from U.S. assets, a measure referred to as a "retaliatory tax."

However, legal experts point out that the 899th clause could impact loan interest payments in a way that harms American companies. Many loan agreements require borrowers to cover tax increases implemented after the agreement is signed. These requirements are known as withholding tax gross-up obligations. Borrowers pay the withholding tax to the U.S. government but must "top up" the payment to ensure the lender still receives the full interest. For example, a 5% withholding tax would require a borrower owing 1000 dollars in interest to pay 50 dollars to the U.S. government and then top up the payment, ensuring the lender still receives 1000 dollars. The borrower's combined tax and interest payment would actually be around 1053 dollars, as the top-up payment itself is also subject to withholding tax.

This double-edged sword effect of the retaliatory tax is significant. Matthew Brown, a partner at the Washington office of A&O Shearman, notes that this measure could involve foreign banks lending to U.S. borrowers from their U.S. branches, a common scenario in syndicated loans. Some borrowers might avoid the proposed 899th clause's increased interest costs by removing non-U.S. lenders from their credit arrangements. However, Brown notes that this depends on the borrower's strength and the availability of lending options. Some lenders might choose to bear the tax cost, as those requiring borrowers to top up might be excluded from future deals. "Memory is long," says Carolyn Alford, a partner at King & Spalding in New York.

If the measure is enacted, lenders from affected countries, rather than borrowers, would be expected to bear the increased costs in subsequent credit transactions. This could make them less willing to lend to U.S. entities. Michael Mollerus, a partner at Davis Polk & Wardwell in New York, notes that French or British banks, for instance, "would have to assess whether they are willing to continue lending if they face the risk of bearing this uncompensated withholding tax."

The tax bill still faces numerous hurdles, including opposition from several Republican senators over cuts to Medicaid and the size of the deficit. The legislation has been criticized by Elon Musk, who described it as a "massive, shameless, pork-filled congressional spending bill" and a "repulsive monstrosity." Despite this, the proposal has already caused unease on Wall Street, with analysts fearing it could drive away foreign investors. Under the current provisions, the tax rate increase is designed to rise over time, starting at 5 percentage points and increasing by 5 percentage points each year until it is 20 percentage points higher than the statutory rate.

House Ways and Means Committee Chairman Jason Smith stated last week that he hopes the 899th clause will serve as a deterrent that is never deployed. Senate Majority Leader John Thune told reporters that the Senate is reviewing the clause. Brown expects the clause's purpose to be "to get countries to the negotiating table" to discuss their corporate tax rules. "I don't believe the intent is to raise U.S. borrowing costs," he said. However, as Wall Street has witnessed numerous times, the "intent" of policymakers often diverges significantly from market realities.