Tax

The year has begun with important developments in the international tax landscape, as countries participating in the OECD Inclusive Framework reached agreement on a package of measures reshaping the operation of Pillar Two (the Global Anti-Base Erosion, or “GloBE,” rules). The “Side-by-Side Package,”¹ announced on January 5, introduces a series of safe harbors and simplification measures intended to reduce compliance burdens and better coordinate the interaction between domestic tax systems and the global minimum tax framework.

The package includes a Simplified Effective Tax Rate (“ETR”) Safe Harbor, an extension of the Transitional Country-by-Country (“CbC”) Reporting Safe Harbor, a Substance-based Tax Incentive Safe Harbor, and a Side-by-Side (“SbS”) System.

Among these measures, the Side-by-Side Safe Harbor stands out, as it may effectively shield U.S.-headed multinational enterprise (“MNE”) groups from the application of the global minimum tax rules, specifically the Income Inclusion Rule (“IIR”) and the Undertaxed Profits Rule (“UTPR”).

Side-by-Side Safe Harbor

Under the Side-by-Side Safe Harbor, an MNE group may elect to have zero top-up tax for IIR and UTPR purposes for a fiscal year if the group’s ultimate parent entity (“UPE”) is located in a jurisdiction with a Qualified Side-by-Side (“SbS”) Regime.

A jurisdiction will be treated as having a Qualified SbS Regime if it operates both an eligible domestic tax system and an eligible worldwide tax system. To qualify, the jurisdiction must effectively achieve a minimum level of taxation at both the domestic and international levels, provide foreign tax credits for qualified domestic minimum top-up taxes (“QDMTTs”) on the same terms as other covered taxes, and satisfy specified enactment timing and review requirements.

Jurisdictions recognized by the Inclusive Framework as having a Qualified Side-by-Side Regime will be listed on the OECD Central Record.² If an MNE group’s UPE is located in such a jurisdiction and the group elects the Side-by-Side Safe Harbor, the safe harbor applies to all of that MNE group’s controlled domestic and foreign operations.

The Side-by-Side Safe Harbor applies to fiscal years beginning on or after January 1, 2026 and does not switch off QDMTTs and does not deem top-up tax to be zero for purposes of computing domestic minimum taxes.

Replacement of the Transitional UTPR Safe Harbor

The package also replaces the existing Transitional UTPR Safe Harbor with a new UPE Safe Harbor, effective January 1, 2026.

Under the UPE Safe Harbor, UTPR liability will be zero for an MNE group if its ultimate parent entity (“UPE”) is located in a jurisdiction that enforces a qualifying UPE regime. The criteria for such a regime largely align with the Side-by-Side framework for an eligible domestic tax system but do not require an eligible worldwide tax system.

Simplified ETR Safe Harbor and Extension of Transitional CbC Reporting Safe Harbor

The OECD also approved a Simplified ETR Safe Harbor, designed to reduce compliance burdens by allowing groups, in specified circumstances, to rely primarily on financial accounting data to demonstrate that no top-up tax arises in a tested jurisdiction. Under this safe harbor, an MNE group’s ETR is determined using a simplified calculation based on income and taxes drawn from the group’s financial reporting information, subject to limited adjustments.

The Simplified ETR Safe Harbor is expected to become available in all jurisdictions beginning in 2027, with limited availability beginning in 2026 in certain circumstances, depending on fiscal year start dates and implementation mechanics.

To support a smooth transition, the OECD agreed to extend the Transitional CbC Reporting Safe Harbor by one additional year, such that it will apply to fiscal years beginning on or before December 31, 2027, provided the fiscal year does not end after June 30, 2029. In addition, the transition rate applicable for 2026 fiscal year will also apply for 2027 fiscal year.

Substance-based Tax Incentive Safe Harbor

The Side-by-Side Package also introduces a Substance-Based Tax Incentives Safe Harbor, aimed at preserving the benefit of certain expenditure-based and production-based tax incentives that are closely tied to economic substance. As noted in the OECD report, this approach reflects the view that incentives linked to substantive activities in a jurisdiction are less susceptible to base erosion and profit shifting risks.

Under this safe harbor, an MNE group may elect to eliminate top-up tax attributable to qualified tax incentives (“QTIs”) by treating such substance-based incentives as an addition to covered taxes. The benefit of QTIs is subject to a Substance Cap, equal to the greater of 5.5% of payroll costs or depreciation of tangible assets in the jurisdiction. Alternatively, on an elective basis (five-year election), an MNE group may apply an alternative cap equal to 1% of the carrying value of eligible tangible assets in the jurisdiction (excluding land and other non-depreciable assets).

The election is available for fiscal years beginning on or after January 1, 2026.

Practical Takeaways

• U.S.-headed and other potentially eligible groups should assess whether the Side-by-Side Safe Harbor could eliminate IIR and UTPR exposure beginning in 2026 while preserving domestic minimum tax obligations.
• MNE groups should update their Pillar Two compliance roadmaps.
• Groups benefiting from tax incentives should evaluate whether the Substance-based Tax Incentive Safe Harbor could mitigate incremental top-up tax.

Despite the progress reflected in the Side-by-Side Package, the Inclusive Framework acknowledged that further improvements are needed and committed to a continued work program aimed at delivering additional clarifications and simplifications to the Pillar Two framework.

We will continue to monitor further OECD guidance and jurisdiction-level implementation of the Side-by-Side Package. If you have questions or would like assistance, please contact: