OECD Pillar Two Side-by-Side System and New Safe Harbors
On January 5, 2026, the Organisation for Economic Co-operation and Development (“OECD”) announced that the Inclusive Framework on Base Erosion and Profit Shifting agreed to a new package of administrative guidance (the “package”) under the Pillar Two global minimum tax (“GMT”) rules.
The centerpiece of the package for US multinationals is the Side-by-Side (“SbS”) Safe Harbor that implements the G7’s June 2025 political agreement to exclude US-parented multinational groups from the GMT’s Income Inclusion Rule (“IIR”) and Undertaxed Profits Rule (“UTPR”) on the grounds that the existing US law is sufficiently robust in its taxation of domestic and foreign profits. The new SbS Safe Harbor operates by allowing multinational enterprise (“MNE”) groups with an Ultimate Parent Entity (“UPE”) located in a jurisdiction with a “Qualified SbS Regime” to elect a deemed Top-up Tax of zero under both the IIR and UTPR across all domestic and foreign operations. Qualified Domestic Minimum Top-up Taxes (“QDMTTs”) are unaffected by the new guidance and, where implemented in relevant jurisdictions, will continue to apply to US-parented groups. While the United States is the only jurisdiction with a Qualified SbS Regime as of January 1, 2026, the package contemplates that other countries may request the Inclusive Framework to assess their tax regime against the eligibility criteria.
Alongside the SbS Safe Harbor, the package introduced a new UPE Safe Harbor for jurisdictions that meet the minimum taxation requirements with respect to domestic income, even if they do not do so with respect to foreign income. The UPE Safe Harbor allows MNE groups parented in the qualified jurisdiction to exclude the UPE jurisdiction profits from the application of the UTPR.
The package also establishes a permanent Simplified Effective Tax Rate (“ETR”) Safe Harbor which is intended to substantially simplify compliance for non US-parented MNEs that remain fully subject to the GMT rules, and extends the Transitional country-by-country (“CbCR”) Safe Harbor by one year. The ETR Safe Harbor is the cornerstone of the package for non-US multinationals as they continue to navigate the GMT across much of the world.
Further, the package creates a Substance-based Tax Incentive (“SBTI”) Safe Harbor, which may eliminate Top-Up Taxes that would otherwise be triggered by certain expenditure-based incentives, including the section 41 research and development (“R&D”) tax credits claimed by US subsidiaries of non-US-parented MNEs.
Overall, the new measures aim to reduce compliance burdens and ensure the proper sequencing and effectiveness of the GMT rules. While the SbS Safe Harbor provides welcome relief for US-parented MNE groups, these groups will still be required to undertake burdensome data collection and processing exercises to accurately and timely file GMT information returns and comply with multiple QDMTTs across implementing jurisdictions. The timely implementation of the SbS Safe Harbor will also be important to non-US MNE groups, as it would reduce the likelihood that the US Congress revisits the enactment of retaliatory taxes that would increase US taxation of non-US multinationals.1
The United Kingdom has already signaled its intention to implement elements of the package into its domestic Pillar Two regime, and the European Commission has confirmed the application of the package in the context of the EU Pillar Two Directive.
In turn, it remains to be seen whether the SbS Safe Harbor will materially influence behavior of governments and taxpayers—for example, by prompting countries to amend their domestic tax laws to more closely align with the US system in order to benefit from the SbS Safe Harbor, or by encouraging certain non-US MNE groups to redomicile their UPE or “invert” into the United States.
I. The Side-by-Side System
a. Policy context and structure
The GMT generally applies to multinational groups with annual consolidated revenues of at least 750 million euros and imposes different taxes (“Top-up Taxes”) to ensure a minimum 15% effective tax rate in every country where the group operates. Very generally, the key components are: (i) QDMTTs, which allow countries to apply Top-up Taxes on domestic profits; (ii) the IIR, which allows the country of the ultimate parent company (or intermediate parent company, when applicable) of a multinational group to collect a Top-up Tax if the effective tax rate of a jurisdiction where the group has subsidiaries or permanent establishments is below 15%; and (iii) the UTPR, which, as a backstop, allows the applying countries to collect a Top-up Tax with respect to the profits of group affiliates in other jurisdictions to the extent they are not subject to an effective rate of at least 15% and are not otherwise subject to the IIR.
The Inclusive Framework recognizes that, while a coordinated GMT should be the primary system to ensure minimum taxation, some jurisdictions already operate minimum taxation regimes applicable to both domestic and foreign income of locally headquartered MNEs. For example, the domestic corporate income tax, the corporate alternative minimum tax (“CAMT”), and CFC‑based inclusions under the Subpart F and Net CFC Tested Income regimes implemented by the United States—together with other anti‑base erosion measures of the US tax system—operate as a worldwide minimum tax comparable to the GMT rules. Where these regimes are understood to share objectives, scope, and policy effects with the GMT, the new guidance provides elective safe harbors. The package therefore introduces two safe harbors available by election to eligible MNE groups—the SbS Safe Harbor and the UPE Safe Harbor—both of which will rely on a centralized eligibility assessment undertaken by the Inclusive Framework, which will also maintain a “Central Record” of qualifying regimes.
b. Side-by-Side Safe Harbor: mechanics and scope
Under the SbS Safe Harbor, where an MNE group’s UPE is located in a jurisdiction with a Qualified SbS Regime, the MNE group may elect to deem the Top-up Tax to be zero under both the IIR and UTPR for all jurisdictions in a fiscal year. A jurisdiction qualifies as having a Qualified SbS Regime only if it (i) has an “eligible domestic tax system” and an “eligible worldwide tax system;” (ii) provides a foreign tax credit for QDMTTs on the same terms as other creditable covered taxes; and (iii) has enacted the eligible systems prior to January 1, 2026, or a later date in accordance with the procedures set forth in the package. Jurisdictions meeting the criteria are listed in the OECD Central Record. As of the date of this publication, the Central Record only lists the United States as having a Qualified SbS Regime.
An “eligible domestic tax system” must meet three cumulative requirements: (1) a nominal statutory corporate income tax rate of at least 20% (after accounting for general preferential adjustments and any subnational corporate taxes including, in the US, state-level income taxes); (2) a QDMTT or corporate alternative minimum tax based on financial statement income at a nominal rate of at least 15% that applies to a substantial portion of in-scope MNE income; and (3) no material risk that in-scope UPEs face sub-15% effective taxation on overall domestic profits (assessed holistically, including treatment of incentives under Pillar Two and safe harbors). While the listing of the United States in the Central Record provides US-parented MNEs with certainty that the United States meets these requirements, the United States’ continued eligibility appears predicated on Congress retaining the CAMT (or some other similar minimum tax) and not materially reducing the regular corporate income tax rate. This said, the US Treasury Department has since provided assurance in public statements that potential new regulations anticipated to soften CAMT’s impact should not impact the United States’ eligibility.
An “eligible worldwide tax system” must (1) tax foreign income of resident corporations on a broad base inclusive of active and passive income of foreign branches and controlled foreign corporations (“CFCs”) (regardless of distribution), allowing only limited exclusions consistent with minimum tax policy (e.g., for generally high-taxed income); (2) contain substantial base erosion and profit shifting risk controls; and (3) present no material risk of sub-15% effective taxation on overall foreign profits of in-scope UPEs. Again, the listing of the United States in the Central Record provides US-parented MNEs with assurance that the United States meets these requirements through its Subpart F and Net CFC Tested Income regimes.
Where a jurisdiction is determined to have a Qualified SbS Regime and is listed in the Central Record, MNE groups with UPEs in that jurisdiction may elect the SbS Safe Harbor for fiscal years beginning on or after January 1, 2026 (or a later date specified in the Central Record). If elected, the SbS Safe Harbor applies across the MNE group’s worldwide operations, including stateless and minority-owned constituent entities, partially owned parent entities, joint ventures, and JV subsidiaries, and reduces to zero any UTPR or IIR Top-up Tax otherwise due at the level of an intermediate parent entity.
c. Interaction with QDMTTs and limitations
The SbS Safe Harbor does not affect the application of QDMTTs. QDMTTs continue to apply in implementing jurisdictions, including with respect to foreign operations of UPEs covered by the SbS Safe Harbor, and remain calculated without pushdown of UPE taxes on CFCs or branches, consistent with existing Pillar Two guidance. Moreover, the package indicates that a domestic minimum Top-up Tax that was to exempt MNE groups which benefit from the SbS Safe Harbor would lose its status as a QDMTT. The package also confirms that all Inclusive Framework members remain committed to crediting QDMTTs on the same terms as other creditable foreign income taxes.
The SbS Safe Harbor is not available to MNE groups whose UPE is in a jurisdiction that lacks a Qualified SbS Regime, even if an intermediate parent entity is resident in a jurisdiction with a Qualified SbS Regime. Thus, the SbS Safe Harbor is not available in the case of so-called “sandwich structures” of non-US parented groups (i.e., subgroup with a US intermediate parent and non-US subsidiaries).
d. UPE Safe Harbor: scope and relationship to SbS Safe Harbor
The UPE Safe Harbor replaces the Transitional UTPR Safe Harbor that expired at the end of 2025. The UPE Safe Harbor applies where a jurisdiction meets the criteria for an “eligible domestic tax system” as of January 1, 2026; it does not need to meet the criteria for an “eligible worldwide tax system” as well. The UPE Safe Harbor provides an exclusion from the UTPR for the profits of the UPE jurisdiction (i.e., the UTPR Top-up Tax allocable to the UPE jurisdiction is deemed to be zero). Qualifying jurisdictions will be listed in the Central Record maintained by the Inclusive Framework. As of the date of this publication, no jurisdiction has been listed as satisfying the UPE Safe Harbor. The UPE Safe Harbor applies for fiscal years beginning on or after January 1, 2026, does not affect the IIR or UTPR with respect to non-UPE jurisdictions, and does not impact QDMTTs.
e. Effective date and reporting
The SbS Safe Harbor applies for fiscal years beginning on or after January 1, 2026 (or a later year set out in the Central Record). However, where constitutional or legislative constraints delay adoption in implementing jurisdictions, the UTPR may continue to apply in the interim even for groups ultimately eligible for the SbS or UPE Safe Harbors, so close monitoring of local legislative processes may be necessary. The package provides that jurisdictions which have not yet adopted the SbS Safe Harbor would not be allocated more than its UTPR percentage of the UTPR Top-up Tax Amount, which would prevent the risk of countries collecting additional Top-up Tax by reason of their delayed adoption of the SbS Safe Harbor.
Moreover, groups must apply the full GMT rules for fiscal years 2024 and 2025, irrespective of later SbS Safe Harbor eligibility. While, overall, the SbS Safe Harbor is a welcome development for US-parented MNEs, the effective date provisions mean that such US MNEs will receive no relief under the SbS Safe Harbor from any IIRs, UTPRs or related reporting requirements that were applicable during 2024 and 2025. US-parented MNEs will need to fully comply with the GMT rules and their associated compliance burdens for this two-year period (subject to the availability of the Transitional UTPR Safe Harbor for the US UPE profits in 2025).
Further, from a compliance perspective, US-parented MNEs will not be fully exempted from requirements to file GMT Information Returns (“GIRs”), since the GIR will be the means by which such MNEs elect into the SbS Safe Harbor. Specifically, the package contemplates that the GIR will be updated to allow an explicit SbS Safe Harbor election in Section 1 of the form, and that MNEs electing the SbS Safe Harbor in jurisdictions with an IIR or UTPR will submit only Section 1 (excluding Section 1.4 high-level summary), while continuing to file the jurisdictional sections of the GIR for QDMTT purposes.
Finally, the timing of adoption of the SbS Safe Harbor across jurisdictions may have implications for the financial statement reporting of US-parented groups. As long as one or more countries have not incorporated the SbS Safe Harbor into their GMT legislation, US-parented groups may be required to recognize Top-up Tax accruals, even if those Top-up Taxes ultimately are not due after the subsequent enactment of legislation implementing the safe harbor.
II. Simplified ETR Safe Harbor
The package also introduces a permanent Simplified ETR Safe Harbor which, if elected by an in-scope group, deems a tested jurisdiction’s Top-up Tax to be zero where either the jurisdiction’s Simplified ETR is at least the minimum rate of 15% or the jurisdiction has a “simplified loss.” In effect, where this safe harbor applies for a tested jurisdiction, an MNE otherwise within the GMT will not incur GMT taxes by reference to that jurisdiction’s income.
The safe harbor is intended to deliver permanent simplification in jurisdictions where the risk of Top-up Tax is low. It will initially co-exist with, and then replace, the Transitional CbCR Safe Harbor (“TCSH”), which has been extended by one year under the package. Where implemented in line with the package, the Simplified ETR Safe Harbor generally applies for fiscal years beginning on or after December 31, 2026 (i.e., beginning in 2027), with earlier availability from 2026 in specified circumstances (namely, where a QDMTT Safe Harbor applies with respect to the tested jurisdiction, only one jurisdiction has taxing rights under the relevant GMT rules with respect to that jurisdiction, or all jurisdictions with taxing rights have enabled early use and the group elects consistently).
In broad terms, the safe harbor simplifies by allowing MNEs to compute the numerator and denominator of a jurisdictional Pillar Two ETR—namely “simplified taxes” and “simplified income”—using financial accounting data from the consolidated reporting packages, with limited, targeted adjustments, rather than applying a full Pillar Two computation. Specifically, under the Simplified ETR Safe Harbor, groups may generally rely on the profit (or loss) and income tax expense already reflected in the consolidated financial statements, remove obvious untaxed items (such as excluded dividends and excluded equity gains and losses), and otherwise leave the accounts largely unchanged. However, in jurisdictions that require use of the local financial accounting standard for QDMTT purposes, the safe harbor must be computed using that local standard unless the jurisdiction allows use of the group’s consolidated financial statement standard. Groups may also include deferred tax to smooth timing differences without applying the full Pillar Two deferred tax “recapture” mechanics. Special adjustments to the Simplified ETR calculation are provided for the shipping and insurance industries
In many higher tax jurisdictions, these shortcuts should enable groups to satisfy the 15% test without running full (and often burdensome) Pillar Two computations. However, where a jurisdiction’s Simplified ETR is (or may be) below 15%, the Simplified ETR Safe Harbor does not apply (unless there is a simplified loss) and groups may still need to undertake full Pillar Two computations to avoid Top-up Tax there. Availability is also phased, with general applicability from 2027 and limited early use from 2026 as noted above.
To promote stability and prevent “safe harbor hopping,” consistency and re-entry rules apply. After electing the Simplified ETR Safe Harbor for a jurisdiction, if the group does not elect it in a later year, it may re-elect it only once it has had no Top-up Tax in that jurisdiction in every fiscal year beginning within the 24 months from the start of the non-election year, based on either (i) full Pillar Two computations or (ii) a Specified Safe Harbor. For this purpose, the TCSH and the QDMTT Safe Harbor are not treated as Specified Safe Harbors. Additional current Top-up Tax attributable to prior years is disregarded for this re-entry test.
Integrity safeguards also apply. To be eligible, groups must adjust their computations to comply with four principles: (i) matching (intra-group income is not recognized later than the corresponding expense and amounts match); (ii) full allocation (all income allocated to a tested jurisdiction); (iii) single expense and loss (deduct once, in one jurisdiction); and (iv) single tax (record taxes once, in one jurisdiction). The Inclusive Framework is also developing a broader anti-arbitrage rule to police cross border shifting of income or taxes and to apply across both safe harbors and the main Pillar Two rules.
Overall, the Simplified ETR Safe Harbor should be a welcome addition—particularly after the expiry of the TCSH—and affected groups should prepare for its operation and availability. The Inclusive Framework has also confirmed ongoing work to complete the permanent simplified safe harbor suite by developing routine profits and de minimis tests for low-risk cases, with conclusions targeted for the first half of 2026. In the future, therefore, further routes may become available for affected groups to fall within the permanent simplified safe harbor of which the Simplified ETR Safe Harbor is currently one element.
III. Extension of the Transitional CbCR Safe Harbor
As mentioned above, to ensure an orderly transition to the Simplified ETR Safe Harbor, the Inclusive Framework extended the TCSH by one year. The transition period now covers fiscal years beginning on or before December 31, 2027, but not including a fiscal year ending after June 30, 2029, and the transition rate is set at 17% for fiscal years beginning in 2026 and 2027. This preserves taxpayer optionality during the transition and maintains temporary relief where CbCR-based Simplified ETR, routine profits, or de minimis tests can be met, pending completion of permanent de minimis and routine profits safe harbors.
IV. Substance-based Tax Incentive Safe Harbor
The SBTI Safe Harbor allows MNE Groups to elect to treat certain Qualified Tax Incentives (“QTI”)—limited to generally available expenditure-based or production-based incentives tied to substantive economic activity—as additions to “adjusted covered taxes,” up to a jurisdictional “Substance Cap” calibrated by reference to payroll and tangible asset substance (with an elective alternative cap equal to 1% of carrying value of tangible assets). The safe harbor eliminates Top-up Tax attributable to qualified incentives by increasing adjusted covered taxes by the lower of the QTI used and the Substance Cap, expressed as the tax value of the incentive. Incentives that merely accelerate timing (e.g., immediate expensing) are excluded unless they create permanent differences via super deductions or enhanced allowances. In particular, this safe harbor is a welcome development for any non-US-parented MNE groups that benefit from such credits, including US subsidiaries of non-US-parented MNEs that benefit from the US R&D tax credit.
1 See prior Legal Updates on Section 899, US Senate Finance Committee Makes Changes to Proposed Section 899 and One Big Beautiful Bill Act Introduces Significant Domestic and International Tax Changes.
