Pillar Two side-by-side arrangements

Update: Further to the publication by the OECD of the side-by-side arrangement and further safe harbours, the EU Commission has published a Commission Notice acknowledging the agreement and confirming that Member States should implement its provisions in the context of the Pillar Two Directive (Council Directive (EU) 2022/2523).

The OECD has published an important document providing for the approval of a “side-by-side system” for applying the Pillar Two rules, as well as containing details of a series of simplification measures for business operating under the rules. It is expected that the side-by-side arrangement will largely exclude US parented companies from the impact of the Pillar Two top-up tax provisions without the US implementing the Pillar Two measures itself. MNE groups headquartered in such jurisdictions will not be excluded from the application of Qualified Domestic Top-up Taxes (QDMTT) on profits in other jurisdictions, however. It is also worth noting that the side-by-side package does not specifically mention the USA at all and, in principle, will be open to other jurisdictions with appropriate provisions in place to qualify as having a Qualified Side-by-Side regime.

Background

The Pillar 1 and Pillar 2 approaches were designed by the OECD Inclusive Framework to deal with problems created for the international tax landscape by the digital economy and involve: revised profit allocation and nexus rules (Pillar One); and a global anti-base erosion rule involving a minimum level of taxation of 15% (Pillar Two).

The overall design of Pillar Two includes two domestic rules (together the Global anti-Base Erosion Rules (GloBE) rules):

• an Income Inclusion Rule (IIR), which imposes top-up tax on a parent entity in respect of the low taxed income of a subsidiary entity; and
• an Undertaxed Payment Rule (UTPR), which denies deductions or requires an equivalent adjustment to the extent the low tax income of a subsidiary entity is not subject to tax under an IIR

In 2025, the Trump administration indicated that it would no longer implement the OECD Pillars. With regard to Pillar Two in particular, the US objected to its extension to include the UTPR. Whilst the basic GloBE rules largely work in a way similar to CFC rules to top up taxes of subsidiaries to 15%, the UTPR will go much further. This will allow jurisdictions to impose additional taxes on members of an MNE group that pay less that the global minimum of 15% in another jurisdiction, including where the ultimate parent company fails to pay 15%. As such, with the US not implementing the GloBE rules domestically, then other jurisdictions would potentially be in a position to charge domestic group companies additional taxes on the basis that their US parent was subject to tax at a rate less than 15%.

In June 2025, the G7 released a statement confirming that agreement had been reached concerning the operation of a side-by-side solution to the application of Pillar Two to US parented groups. However, it was clear that the G7 statement represented a broad understanding of the way ahead and much work would still be needed to finalise the terms of the agreement. The January 2026 publication is the culmination of that work.

Side-by-side arrangement

The side-by-side arrangement will allow jurisdictions to be recognised as, essentially, having existing anti-BEPs rules which are complementary to the Pillar Two rules. In those circumstances, MNEs which are headquartered in such jurisdictions will be able to benefit from additional safe harbour provisions which treat the amount of any top-up tax otherwise due under the IIR or UTPR as zero. Whilst the side-by-side (SbS) arrangement is clearly aimed at allowing the USA such that its headquartered MNEs will not be directly affected by its decision not to implement the Pillar Two rules, in fact the measures are drafted in a general way and, in principle, will allow other jurisdictions to apply to be recognised as a jurisdiction with a qualified SbS regime.

The document contains a list of requirements for a jurisdiction to be treated as one qualifying for SbS treatment, including a domestic tax system with a minimum 20% statutory nominal corporate tax rate, a QDMTT or equivalent of at least 15% and no material risk that MNE groups headquartered in the jurisdiction will be subject to an effective tax rate on overall domestic profits below 15% (taking into account the treatment of tax incentives etc under the GloBE rules). Such jurisdictions must also have a worldwide tax system which ensures the taxation of foreign income received by headquartered MNE groups which operates to address BEPS risks. Where a jurisdiction has been vetted by the Inclusive Framework and accepted as a Qualified SbS regime, it will be listed as such on a Central Record. An MNE group with its ultimate parent located in a jurisdiction that has a Qualified SbS regime can elect into the SbS Safe Harbour.

As mentioned above, where the SbS Safe Harbour applies, then for the purposes of applying the IIR or UTPR, the top-up tax is deemed to be zero with respect to all of that MNE group’s constituent entities. However, the SbS Safe Harbour does not affect the application of QDMTTs, which will continue to apply to the foreign operations of MNE groups headquartered in a jurisdiction with a Qualified SbS regime.

The continuing application of the SbS Safe Harbour will, of course, require monitoring to ensure that the regime continues to qualify. Therefore, there will be requirements to inform the Inclusive Framework of material changes. In addition, the Inclusive Framework will also carry out a “stocktake” by 2029 to assess any unintended effects, such as any emerging material competitive imbalances and negative trends in taxpayer behaviour that might be facilitated by the Safe Harbour. The Inclusive Framework then commits to take action to address any substantial identified risks to the level playing field or BEPS.

Simplifications

The publication also details a number of simplifications to the application of the rules. These include:

The Simplified ETR Safe Harbour: This safe harbour seeks to address a key concern of the business community by substantially reducing the compliance burden associated with the GMT in a meaningful share of jurisdictions where in-scope multinational enterprise groups operate. Under this safe harbour, an MNE Group’s ETR is determined pursuant to a simple calculation based on the income and taxes drawn from the MNE Group’s reporting packages with minimal adjustments. The Simplified ETR Safe Harbour will be available to MNE Groups in all jurisdictions from the beginning of 2027 or the beginning of 2026 in certain circumstances. It is perhaps, however, worth noting that whilst simplified, the description of the simplified system still covers 57 pages of the 2026 document.

Transitional CbCR Safe Harbour extension: To allow sufficient time for smooth implementation of the Simplified ETR Safe Harbour, the Inclusive Framework has also agreed to an extension of the Transitional CbCR Safe Harbour for one year to cover fiscal years beginning on or before 31 December 2027. This will provide in-scope taxpayers the choice of opting either for the Simplified ETR Safe Harbour or the Transitional CbCR Safe Harbour during a transition period.

Work programme for additional simplification: The Inclusive Framework is also committed to a work programme to achieve additional clarifications and simplifications, including:

• finishing the ongoing work on a routine profits test and a de minimis test
• continuing to work towards further simplification of the GloBE Rules themselves with a particular focus on continuity issues, to ensure that taxpayers can benefit from the simplifications under the safe harbour even where, in a subsequent year, they may not qualify for that safe harbour and are required to calculate their ETR under the full GloBE Rules
• taking forward further administrative guidance on technical issues relating to the GloBE Rules; and
• exploring integration of the simplified calculations in the Simplified ETR Safe Harbour into the design of the GMT

Substance based tax incentives

Beyond its work on simplifications, the Inclusive Framework recognises tax incentives are a widely used tool to promote substantial investments and economic development. The Inclusive Framework has therefore adopted a safe harbour to allow MNE Groups to continue to benefit from certain tax incentives that are strongly connected to economic substance in the jurisdiction. This treatment is subject to strict limits that ensure the GMT will continue to provide an effective floor on income tax competition between jurisdictions.

The Substance-based Tax Incentive (SBTI) Safe Harbour allows an MNE Group to treat certain Qualified Tax Incentives (QTIs) as an addition to the Covered Taxes of the Constituent Entities located in the jurisdiction. A QTI is one that is generally available to taxpayers and is calculated based on expenditures incurred (an expenditure-based incentive) or on the amount of tangible property produced in the jurisdiction (production-based tax incentive). A Substance Cap limits the allowance for QTIs by reference to the amount of substance in the jurisdiction. The cap is equal to the greater of 5.5% of the payroll costs or depreciation of tangible assets in the jurisdiction. On an elective basis, the MNE Group can use an alternative cap which is equal to 1% of the carrying value of tangible assets in the jurisdiction.