New Section 892 Guidance Provides Transition Relief to Sovereign Investors

On May 29, 2026, the Treasury Department and IRS released guidance (the “2026 Proposed Regulations”) delaying the applicability date of recently-issued proposed regulations under Section 892 of the Internal Revenue Code (the “2025 Proposed Regulations”) and excluding certain existing investments from the new rules entirely through a grandfathering provision. O’Melveny’s client alert about the 2025 Proposed Regulations can be found here. By way of background, Section 892 generally provides tax exemptions on certain U.S. investments to foreign governments and their controlled entities but does not extend the exemption to income from “commercial activities.”

The 2025 Proposed Regulations, which were issued last December, addressed both (i) when the acquisition of debt constituted a “commercial activity” for purposes of Section 892 and (ii) whether a foreign government has effective control over an entity engaged in commercial activities. The 2025 Proposed Regulations were proposed to apply to taxable years beginning on or after a Treasury decision finalizing those regulations.

Responding to taxpayer concerns about the applicability dates of the 2025 Proposed Regulations, the newly issued 2026 Proposed Regulations include both transition relief and grandfathering provisions. Under the transition relief provision, a foreign government would not be subject to the new rules until the later of: (1) 90 days after the 2025 Proposed Regulations are finalized, or (2) the beginning of its first taxable year after finalization (the “Transition Period”). Under the grandfathering provision, the 2025 Proposed Regulations would not apply to debt or equity acquired by a foreign government before the end of the Transition Period or to acquisitions made pursuant to a binding commitment entered into before that date. Instead, those earlier acquisitions would remain subject to the rules in effect before the 2025 Proposed Regulations.

The 2025 Proposed Regulations created concern about their application to existing investments of foreign governments and their controlled entities. While the 2026 Proposed Regulations do not yet address taxpayers’ concerns about the substantive rules in the 2025 Proposed Regulations, the transition relief constitutes a welcome development. Sovereign investors would be well-advised to assess which of their existing debt and equity investments may qualify for transitional relief under the 2026 Proposed Regulations.

This memorandum is a summary for general information and discussion only and may be considered an advertisement for certain purposes. It is not a full analysis of the matters presented, may not be relied upon as legal advice, and does not purport to represent the views of our clients or the Firm. Billy Abbott, an O’Melveny partner licensed to practice law in California and New York; Luc Moritz, an O’Melveny partner licensed to practice law in California; Jan Birtwell an O’Melveny partner licensed to practice law in England & Wales; George W. Duncan, an O’Melveny associate licensed to practice law in England & Wales; and Ben Morain, an O'Melveny associate licensed to practice law in California, contributed to the content of this newsletter. The views expressed in this newsletter are the views of the authors except as otherwise noted.

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