Among the other material additions to the Pillar Two rules discussed below, the package (available here) sets forth a new side-by-side safe harbor (SbS Safe Harbor) under which a multinational enterprise group (MNE Group) with its ultimate parent entity (UPE) in a jurisdiction with sufficiently robust domestic and international tax rules may elect full exemption from the undertaxed profits rule (UTPR) and the income inclusion rule (IIR), but not Qualified Domestic Minimum Top Up Taxes (QDMTTs).
So far, the United States is the only jurisdiction that the OECD has added to a Central Record of jurisdictions that qualify for the SbS Safe Harbor. Accordingly, U.S.-headed MNE Groups are on their way to a complete exemption from the UTPR and the IIR, assuming timely adoption of the SbS Safe Harbor in other jurisdictions.
A big question is whether any other jurisdictions will also be able to benefit from the new SbS Safe Harbor or its cousin the UPE Safe Harbor, which only limits the application of the UTPR with respect to constituent entities located in the UPE’s jurisdiction.
For MNE Groups headquartered outside the U.S. that remain subject to Pillar Two, the side-by-side package offers some welcome simplifications. Moreover, the package makes material changes to the treatment of certain local tax incentives, promising greater flexibility as to the form of tax incentives that will be respected under Pillar Two. These changes, each of which is discussed in greater detail below, generally appear to be good news for both tax administrations and taxpayers but mean navigating yet more rules.
How did we get here?
While many jurisdictions in 2025 were shifting into the implementation stage of the global minimum tax (see our alert here), on the first day of the Trump administration in January, the administration issued an executive order withdrawing the U.S. from the OECD pillars project (see our alert here). Among other concerns, the U.S. was particularly troubled by one aspect of the global minimum tax: the UTPR, which could cause a top-up tax on U.S. profits to be owed by a non-U.S. subsidiary of a U.S.-headed MNE Group even if the U.S. itself did not adopt the Pillar Two rules.
The UTPR is seen by the OECD as a crucial mechanism in Pillar Two as it encourages a jurisdiction to adopt Pillar Two or risk tax being collected elsewhere on profits arising in that jurisdiction. The U.S., on the other hand, views the UTPR as an extraterritorial tax and, in May 2025, the U.S. Congress proposed a new section 899 tax under the bills that led to the One Big Beautiful Bill Act. This would have imposed additional U.S. taxes on certain payments received by persons with a sufficient connection to countries that enacted “unfair foreign taxes,” which included, among others, countries with a UTPR.
With the entire Pillar Two project on the line, the G7 in June 2025 reached an agreement in principal with the U.S. to adopt a “side-by-side” system under Pillar Two that would exclude U.S.-headed MNE Groups from both the UTPR and the IIR. Following this agreement, the Trump administration encouraged Congress to drop the proposed section 899 tax, and the One Big Beautiful Bill Act was enacted shortly thereafter without it.
While this dealt with the immediate threat of section 899, many members of the Inclusive Framework were concerned that this concession would undermine the principles underpinning Pillar Two and would put other jurisdictions at a competitive disadvantage. If concessions were to be given to U.S. multinationals, it was argued that work should also be done to ease the compliance burden for MNEs in those jurisdictions that remained obliged to apply the Pillar Two rules.
The U.S. also had concerns around the impact of Pillar Two on its tax credits, including the research and development tax credit, as such credits could lead to a lowering of the effective tax rate (ETR) resulting in non-U.S. headed MNE Groups having to pay top-up tax in other jurisdictions in respect of their U.S. profits, potentially wiping out the benefit of the incentives the U.S. wanted to grant to its own taxpayers in order to encourage certain behaviors. This concern was shared by other jurisdictions that also wanted more flexibility on the tax incentives they could offer. Other factors were also at play, including the U.S. opposition to national digital services taxes and the continuing battle on tariffs.
The pressure was on, with some of the transitional provisions that protected U.S.-headed MNE Groups from having to apply Pillar Two in practice, such as the UTPR Safe Harbor, expiring at the end of 2025. The Inclusive Framework hoped to have a “side-by-side” agreement in place by the end of 2025, but objections were still being raised into December, including from some EU member states. The December 31, 2025 deadline came and went with no sign of an agreement. But finally, on January 5, 2026, a deal was reached and the side-by-side package was released.
What is the side-by-side package?
The package takes the form of new OECD Administrative Guidance, which will in due course be incorporated into the OECD’s Model Rules on Pillar Two and includes four new safe harbors and the extension of an existing safe harbor.
There are three main aspects to the package:
(i) Simplification of the Pillar Two rules to reduce compliance burdens where there is a very low risk of any tax being due under Pillar Two (including a new Simplified ETR Safe Harbor)
(ii) A new category of tax incentives (Qualified Tax Incentives), providing beneficial treatment for certain local tax incentives provided there is sufficient substance in a jurisdiction (via a new Substance-based Tax Incentive Safe Harbor)
(iii) Two new safe harbors for groups with UPEs located in jurisdictions with eligible tax systems that subject profits to minimum levels of tax (via the new SbS Safe Harbor and UPE Safe Harbor)
It is this third category that has attracted the most media attention and will be of most interest to U.S.-headed MNE Groups. But for other MNE Groups, the simplifications may prove more significant, and those who can access the new Substance-based Tax Incentive Safe Harbor may well find this aspect particularly attractive.
Simplifying Pillar Two
Few people would dispute the fact that the Pillar Two rules are very complex. Both tax administrations and taxpayers have struggled to navigate these rules and have called for them to be simplified to ease the disproportionate compliance burden, particularly in cases where no tax is at stake. As such, the simplifications set out in the package are welcomed. However, it does mean another set of rules to digest and apply and, in this interim period before countries implement the rules, a degree of uncertainty as to their application.
The core simplification offered by the package is effectively a simplified version of Pillar Two that can be applied on an elective basis where the OECD acknowledges there is a very low risk of any top-up tax being payable. This takes the form of a permanent “Simplified ETR Safe Harbor.”
The Simplified ETR Safe Harbor builds on the principles behind the existing Transitional CbCR Safe Harbor and was based on an approach put forward by Business at OECD (BIAC) with simplified calculations generally based on an MNE Group’s consolidated financial statements with minimal adjustments. Where the simplified ETR for a “Tested Jurisdiction” is greater than or equal to 15% (the Minimum Rate), or there is a (simplified) loss, a MNE Group can elect for the Simplified ETR Safe Harbor to apply such that the top up tax for such Tested Jurisdiction for that fiscal year will be deemed to be zero.
The simplified ETR is determined by taking a simplified calculation of income and dividing it by a simplified calculation of the tax expense, in each case generally based on amounts in the consolidated financial statements, subject to certain compulsory and optional adjustments. The Tested Jurisdiction concept means that calculations are done on a jurisdictional basis, but with separate calculations required for joint ventures and minority-owned constituent entities and sub-groups.
As the eligibility for the Simplified ETR Safe Harbor is tested annually, it is possible for entities to move in and out of the safe harbor, although there are re-entry requirements such that in effect an entity that falls out of the safe harbor must go two years without a top-up tax liability (which can include benefiting from other safe harbors) before it can access the safe harbor again. The Simplified ETR Safe Harbor applies from fiscal years commencing on or after December 31, 2026, but jurisdictions can choose to apply it from December 31, 2025.
While any simplification is viewed positively, the rules are still relatively complex to apply. There will inevitably still be questions for taxpayers as to how exactly the rules will be applied in a particular jurisdiction until domestic laws are amended. Depending on how different jurisdictions approach this, some businesses may not be able to benefit from these simplifications until 2027.
To assist with this, the existing Transitional CbCR safe harbor is being extended for another year, although note that under this safe harbor the Simplified ETR has to be 17% or more for 2026 and 2027. The extension of the transitional safe harbor may also help those who have been relying on its routine profits or de minimis limbs, as the new Simplified Safe Harbor does not contain these options. Work on replacing those two aspects of the transitional safe harbor is still ongoing and is expected to conclude by June 2026.
This is not the end of the simplification process. The Inclusive Framework is working on simplifying the reporting obligations where the new Simplified ETR Safe Harbor applies. In addition, consideration is being given to how the Pillar Two rules can be further simplified, in particular for those who temporarily fall out of the Simplified ETR Safe Harbor. There is also work promised on streamlining reporting obligations more generally, continuing to address technical issues that have arisen in practice and integrating the new Simplified ETR Safe Harbor into the OECD's Model Rules.
Substance-based tax incentives
The second aspect of the package is a new category of substance-based tax incentives, Qualified Tax Incentives (QTIs). The types of incentives that can qualify under the new Substance-based Tax Incentives Safe Harbor are broader and receive more beneficial treatment than the existing categories of Qualified Refundable Tax Credits (QRTCs) and Marketable Transferable Tax Credits (MTTCs).
This is best illustrated with simple examples. For the purposes of these examples, note that the ETR for an MNE Group in a jurisdiction is calculated by taking adjusted covered taxes ( as defined in the OECD's Model Rules, or ACT) and dividing it by income as calculated under Pillar Two rules (referred to in the rules as GloBE Income). In the absence of the Substance-based Tax Incentives Safe Harbor, tax credits other than QRTCs and MTTCs result in a reduction in adjusted covered taxes, thereby reducing the overall ETR.
For example, take a group with ACT of 1,500 and GloBE Income of 10,000—its ETR would be 15%. If it received a tax credit, other than a QRTC or MTTC, that reduced its tax liability by 100, its ACT would be reduced to 1,400, resulting in an ETR of 14% (1,400/10,000).
If, however, the credit was a QRTC or MTTC, it would not reduce ACT but would be added to GloBE Income, resulting in a higher ETR of 14.9% (1,500/10,100). A QTI, on the other hand, would also not reduce ACT and would not require a corresponding addition to GloBE Income, providing a more beneficial impact than QRTCs and MTTCs do currently—in our example the ACT would remain at 1,500, with GloBE Income remaining at 10,000, resulting in an ETR of 15% (1,500/10,000).
So which tax incentives benefit from this treatment? To be a QTI, the incentive must be expenditure-based or production-based, but the definition of a QTI is not limited to tax credits. A QTI must reduce the current or future liability in relation to a "Covered Tax" (as to which see below), and so can apply to enhanced allowances, tax exemptions and preferential rates of tax. It therefore provides greater flexibility for jurisdictions in the type of incentives they can offer.
The incentive must, however, be generally available, and therefore excludes agreements bilaterally agreed between governments and multinationals. It must also reduce a Covered Tax—this is a concept defined in the OECD Model Rules and would, for instance, exclude incentives in relation to consumption taxes, payroll taxes, stamp taxes and DSTs.
A core principle is that QTIs are intended to encourage investments in substance in a jurisdiction, and therefore the amount of benefit that can be obtained is limited by a substance cap. This is the greater of 5.5% of payroll costs or depreciation of tangible assets in the jurisdiction.
Alternatively, an MNE Group can elect to choose a cap of 1% of the carrying value of tangible assets in the jurisdiction. The amount of benefit is also limited to the amount of QTI “used” in a fiscal year, as explained in detail in the commentary. It is possible to elect for QRTCs and MTTCs (or portions thereof) to be treated as QTIs, provided they meet the QTI conditions.
An MNE Group must elect for the Substance-based Tax Incentive Safe Harbor to apply. The Substance-based Tax Incentive Safe Harbor election is available for fiscal years beginning on or after January 1, 2026. Although expressed as a safe harbor, it seems to be less of a safe harbor in the traditional sense and more of an election for beneficial treatment to apply.
This new QTI concept, which favours industrial tax incentives and international tax competition, is important. Specifically, it may allow for greater use of incentives such as energy tax incentives, research and development (R&D) incentives and patent boxes, although it remains to be seen whether the substance cap will prevent MNE Groups from reaping significant benefits from this new provision.
The side-by-side system
The final, and most hotly anticipated, aspect of the package is the side-by-side system. This provides for two new safe harbors, the SbS Safe Harbor and the UPE Safe Harbor. The SbS Safe Harbor and the UPE Safe Harbor are available for fiscal years beginning on or after January 1, 2026.
The idea of each safe harbor is that MNE Groups that are headquartered in eligible jurisdictions (i.e., those that have systems that are accepted as having laws that ensure minimum levels of tax) can elect for a safe harbor to apply, which will shield group entities from the UTPR, and in the case of the SbS Safe Harbor, from the IIR (but not QDMTTs) and from the corresponding filing obligations.
To be within the SbS Safe Harbor, extensive requirements must be met. The jurisdiction of the UPE must have “Qualified SbS Regime”, which means it:
- has an eligible domestic tax system (requiring a corporate income tax rate of at least 20%; a qualifying domestic minimum top-up tax or corporate alternative minimum tax; and no material risk that in-scope MNE Groups headquartered in the jurisdiction will be subject to an ETR on the overall profits of domestic operations below 15%)
- has an eligible worldwide tax system (requiring a comprehensive tax regime applicable to all corporations on foreign income, with only limited exclusions allowed; mechanisms to address BEPS risks; and no material risk that in-scope MNE Groups headquartered in the jurisdiction will be subject to an ETR on the overall profits of foreign operations below 15%)
- provides a foreign tax credit for QDMTTs1
- has already enacted these rules (new systems can be considered but not until 2027).
Those jurisdictions that the Inclusive Framework determines have a Qualified SbS Regime will be recorded on a Central Record (available here). The only country currently listed on the Central Record as at January 7, 2026 was the United States.2
Accordingly, at least for the time being, the SBS Safe Harbor would enable U.S.-headed MNE Groups to avoid the application of the IIR and the UTPR, provided prompt domestic adoption of the SbS Safe Harbor, as the OECD encourages in the package.
On the other hand, it is unclear whether other jurisdictions will be able to satisfy the rigorous criteria to be a Qualified SbS Regime, and this may well have been intentional to ensure the application of the SbS Safe Harbor was de facto limited to U.S.-headed MNE Groups.
Furthermore, while the rules provide a safe harbor from both the IIR and the UTPR, even for those within the safe harbor, the rules deliberately preserve the role of QDMTTs, with the OECD noting the crucial role of QDMTTs in ensuring the protection of local tax bases, particularly in developing countries. In that regard, the SbS Safe Harbor addresses many Pillar Two concerns for U.S.-headed MNE Groups but not all.
For instance, many of the Pillar Two issues for U.S.-headed MNE Groups entering into joint ventures (JVs) (see our alert here) continue to be present for U.S.-headed MNE Groups that elect into the SbS Safe Harbor. Indeed, while the SbS Safe Harbor is in effect, a U.S.-headed MNE Group may no longer be inclined to own its interest in a consolidated JV through an entity in an IIR jurisdiction simply to avoid the application of the UTPR on 100% of the JV’s top-up tax. Similarly, where a U.S.-headed MNE Group’s consolidated JV is a partially-owned parent entity (POPE), the IIR should no longer apply at the level of the POPE.
On the other hand, given the continued application of QDMTTs to U.S.-headed MNE Groups, they cannot avoid the compliance costs and risks associated with Pillar Two entirely. For example, returning to the JV context, Pillar Two indemnities may still be relevant to other shareholders of a JV that is consolidated with a U.S.-headed MNE Group to address the potential for top-up tax to be owed under a QDMTT regime as a result of activities occurring in the relevant jurisdiction either within, or outside of, the JV (as applicable).
Similarly, Pillar Two indemnities may still be relevant to U.S.-headed MNE Groups that invest in a JV that is consolidated with a non-U.S. headed MNE Group, due to both QDMTTs and the potential application of the POPE rule at the level of the JV.
Moreover, a noteworthy gap in the SbS Safe Harbor as it relates to the United States is that it would not provide an exemption to non-U.S. headed MNE Groups even in respect of a sizable U.S. subgroup, which itself may have significant U.S. and non-U.S. operations sitting below it. This is particularly noteworthy because such non-U.S. headed MNE Groups would be subject to the same domestic and international U.S. tax rules applicable to U.S.-headed MNE Groups in respect of their U.S. subgroups.
The second safe harbor, the UPE Safe Harbor, is less generous, but still potentially helpful for jurisdictions that qualify, if any. If the jurisdiction of the UPE is a “Qualified UPE Regime,” the constituent entities located in that jurisdiction will be exempt from the UTPR (but not the IIR or QDMTTs). This safe harbor is intended to replace the Transitional UTPR Safe Harbor that expired December 31, 2025.
To be a Qualified UPE Regime, the jurisdiction must have an eligible domestic tax system (defined in the same way as for the SbS Safe Harbor above). Constituent entities in other jurisdictions are still subject to the UTPR or IIR (for instance this means the IIR could still be applied to an Intermediate Parent Entity).
Although no jurisdictions are listed in the Central Record as falling within this category as at January 7, 2026, jurisdictions with existing regimes that they think fall within the relevant criteria can request to be assessed to be a Qualified UPE Regime or a Qualified SbS Regime in the first half of 2026.
In terms of MNE Groups being able to rely on these safe harbors now, the package indicates that if a jurisdiction adopts these safe harbors into its domestic law, it is expected to do so with retrospective effect. The commentary notes in this regard that the safe harbors are elective and are intended to benefit taxpayers, which could ease constitutional concerns around retroactivity.
However, the OECD does recognize that some jurisdictions may not be able to adopt the provisions retrospectively on constitutional grounds, in which case the safe harbors should be implemented from the earliest practical date. There is a helpful footnote that states that if a jurisdiction has not yet adopted the safe harbor, it would not be allocated more than its UTPR percentage of the UTPR top-up amount, thereby preventing the risk that all the UTPR would be payable in that jurisdiction.
There are various mechanisms included in the package to try to preserve the integrity of Pillar Two. Significantly, this includes the so-called "stock take" that the OECD will undertake by 2029 to monitor the safe harbors and the level of implementation of QDMTTs in order to ensure a level playing field is maintained for all Inclusive Framework members. The OECD notes that as part of the stocktake they will assess “negative trends in taxpayer behaviors,” which include surges in profits in low-tax jurisdictions without QDMTTs and, notably, inversions.
In that regard, before MNE Groups consider significant changes (e.g., redomiciling to the U.S.) in light of the more favorable Pillar Two rules offered to U.S.-headed MNE Groups, consideration must be given to a number of factors, including not only the full breadth of relevant U.S. tax laws and the potential changes that may be made to those but also the possibility that the OECD later recommends changes to, or the elimination of, the SbS Safe Harbor based on the stocktake.
What next?
The release of the side-by-side package is not the end of the story. It has been said that the details of implementation of the side-by-side deal will continue to be discussed for many years. Indeed, while international agreement has been reached, the work of implementing it into domestic law has not yet begun.
In some cases, most notably the Substance-based Tax Incentive Safe Harbor, the safe harbor concept seems to have been stretched to its very limit. A cynic might wonder if one reason the rules have been expressed in this way is to squeeze the changes within article 32 of the EU’s Pillar Two Directive which permits internationally agreed safe harbors, thereby bypassing the need to amend the directive, which would require unanimity across all EU member states.
Some jurisdictions specifically require their existing domestic Pillar Two laws to be read in line with OECD administrative guidance, as updated from time to time, and this may well help the new provisions to have some weight in those jurisdictions in this period before they are implemented into domestic law. And implementation may well take some time, for instance, the UK government has already indicated that the Finance Bill cycle means it could be 2027 before these rules are enacted in the UK.
It seemed an impossible task to save the Pillar Two project while allaying U.S. concerns and this package may just be enough to achieve this. The OECD package represents a ‘recalibration’ of the global minimum tax, coordinating it with the US worldwide corporate tax system, and with new international tax trends that favour economic and industrial competitiveness in a new geopolitical-economic framework. But while the changes are as a whole intended to be helpful in the long run to both tax administrations and taxpayers, we are likely to have to make our way through a further period of turbulence and uncertainty before we reach settled ground.
Footnotes
1. In Notice 2023-80, the U.S. Treasury Department and Internal Revenue Service announced that forthcoming proposed regulations will provide that QDMTTs are generally creditable in the United States, including for purposes of the subpart F and GILTI high-tax exceptions. Taxpayers are permitted to rely on the guidance in Notice 2023-80 until the date that the forthcoming proposed regulations are published in the Federal Register.
2. Interestingly, the United States was included in the Central Record despite the fact that, under the U.S.’s net CFC tested income (formerly global intangible low-taxed income or GILTI) regime, net CFC tested income is only taxed at a rate of 12.6% (and no residual U.S. tax will be imposed on non-U.S. earnings if the rate of non-U.S. tax is at least 14%, taking into account the 90% foreign tax credit allowed by the U.S.). Given this falls below the 15% threshold, we can only surmise that the inclusion of the United States in the Central Record was based on a broader analysis of the overall U.S. tax system.
