A side-by-side solution has arrived for Pillar Two

As introduced in the 2025 Year-end tax considerations for international tax planning article, in June 2025 an informal agreement was reached between the G7 member countries to construct a side-by-side solution that would exempt U.S. companies from tax under two of the three charging provisions of the global minimum tax (GMT) scheme: the income inclusion rule (IIR) and the undertaxed profits rule (UTPR). The imposition of these top-up taxes, the UTPR being particularly troublesome, on U.S. income has been one of the hot button issues surrounding Trump’s “America First” policy on the tax front. The Organisation for Economic Co-operation and Development (OECD)’s Inclusive Framework (IF) has formalized this side-by-side solution, releasing the “Side-by-Side Package” on Jan. 5, 2026, after months of intense negotiation between IF member countries. The Side-by-Side Package introduces the new side-by-side safe harbor (SbS safe harbor) providing in-scope U.S. headquartered multinational enterprise (MNE) groups, or rather MNE groups with U.S. ultimate parent entities (UPEs), the fuller exemption sought from application of each the IIR and the UTPR with effect for fiscal years beginning on or after Jan. 1, 2026 (as subject to local law enactment). The Side-by-Side Package also delivers a substance-based tax incentive (SBTI) safe harbor as well as requested “simplifications” that were sought after by the global business community and tax authorities alike. These simplifications come in the form of, inter alia, the simplified effective tax rate (ETR) safe harbor, a permanent version of the transitional UTPR safe harbor (the UPE safe harbor), and an extension of the transitional country-by-country reporting (CbCR) safe harbor by one year.

Key takeaways

• While the SbS safe harbor is a needed win for U.S. headquartered MNE groups starting in 2026, in-scope taxpayers still need to meet the requirements of the transitional safe harbors for relief for 2024 and 2025. Further, the applicability of the SbS safe harbor will ultimately rest on Pillar Two jurisdictions to effect this (and other updates) into local law, which will require in-scope U.S. MNEs to stay closely attuned to global Pillar Two updates (especially in the case of a jurisdiction that is unable to make the SbS safe harbor retroactively effective to first fiscal years beginning on or after Jan. 1, 2026).
• The guidance does not remove the compliance burden of filing the GloBE information return (GIR), which will still be required for purposes of annually electing the SbS safe harbor as well as satisfying reporting requirements for locally imposed qualified domestic minimum top-up tax (QDMTT) where applicable (the QDMTT being the third of the aforementioned charging provisions).
• While the Side-by-Side package touts “simplification”, the package itself is 88 pages long with most of the package being dedicated to providing guidance on the so-called “simplified” ETR safe harbor. In-scope MNEs should ensure they are familiar with the requirements for this overly complex safe harbor before considering its election.
• The new substance-based tax incentive (SBTI) safe harbor provides MNE groups around the globe with a more favorable treatment for qualified tax incentives (QTIs), which may relieve some or all top-up taxes where the ETR falls below the 15% minimum tax rate. The SBTI safe harbor may be particularly meaningful to U.S. constituent entities of foreign-parented MNE groups (which not eligible for the SbS safe harbor) taking advantage of research and developmental (R&D) credits as this credit had not been more favorably viewed as a qualified refundable tax credit (QRTC).
• In-scope MNE groups are encouraged to accelerate dialogue with their external financial statement auditor as to an agreed approach forward to integrate this new guidance with respect to each year-end (e.g., incremental disclosure needed for calendar year 2025 filers) and prospective interim financial reporting. For more on Pillar Two financial statement considerations, please see companion piece: Pillar Two ASC 740 financial tax accounting considerations.
• This new guidance should be carefully integrated when framing (or modeling for) merger and acquisition transactions and other structuring (or restructuring) initiatives. This might include a particular focus on a proper alignment for the jurisdictional situs of the UPE of an in-scope MNE group considering that, thus far, only the U.S. tax system has been identified as being a qualified SbS regime limiting (initially at least) eligibility for electing the SbS safe harbor to U.S. headquartered MNE groups alone.

The table below summarizes all available Pillar Two safe harbors (including those available during the transition period) detailing (at a high level) what each safe harbor is, to which charging provision each applies, when each safe harbor applies (or is available to be applied) and with respect to which jurisdiction each applies. Safe harbors added by the Side-by-Side Package are also indicated below.

Note: The below safe harbors are as described in the OECD Model Rules and other administrative guidance. Each adopting jurisdiction is required to implement these rules, in whole, or in part, into their local law. Further, the speed to which each jurisdiction implements these rules, particularly with respect to the new safe harbors in the Side-by-Side Package, may vary.

As noted above, the Side-by-Side Package covers three main categories: the side-by-side system, substance-based tax incentives, and material simplifications, each of which is discussed briefly below.

The side-by-side system

The side-by-side (SbS) safe harbor

As discussed above, the SbS safe harbor is generally available for eligible MNE groups for fiscal years beginning on or after Jan. 1, 2026. MNE groups are eligible for this safe harbor if the UPE is located in a jurisdiction operating under a “qualified SbS regime”. If this election is made for a fiscal year, any IIR or UTPR top-up taxes for that year will be treated as zero for the constituent entities of the MNE group. To be considered a qualified SbS regime, the regime must be an “eligible domestic tax system,” an “eligible worldwide tax system” (each of which having been generally in place prior to Jan. 1, 2026, however, later submissions to the IF to determine eligibility can be made before 2029) and allow for an FTC for QDMTTs. The IF will publish to the Central Record if it determines a jurisdiction has a qualified SbS regime for which, to date, only the U.S. is listed as qualifying.

To qualify as an eligible domestic tax system, the UPE jurisdiction’s tax system generally must:

• Have a statutory nominal corporate income tax rate of at least 20%
• Have a QDMTT or a qualifying corporate alternative minimum tax that is based on financial statement income with a nominal rate of at least 15% (e.g., the “CAMT” in the U.S.), and
• Have no material risk that an MNE group headquartered in the jurisdiction will be subject to an ETR of less than 15% on profits from domestic operations.

To qualify as an eligible worldwide tax system, the UPE jurisdiction’s tax system generally must:

• Have a tax system that imposes tax on foreign income of resident corporations, including active and passive income of foreign branches and controlled foreign companies with minimal exclusions consistent with IF policy objectives (e.g., income already subject to a high rate of tax being an appropriate exclusion)
• Have mechanisms that unilaterally address base erosion and profit shifting (BEPS) risks, and
• Have no material risk that the MNE group headquartered in the jurisdiction will be subject to an ETR of less than 15% on profits arising from foreign operations.

Baker Tilly observations:

• The QDMTT will remain unaltered by the side-by-side solution, and consequentially, the undertaxed profits of non-U.S. constituent entities of a U.S. MNE group could still be subject to top-up tax at the local constituent entity jurisdiction level. Importantly, the SbS safe harbor (broader Side-by-Side Package) makes no changes to required reporting for the 2024 and 2025 years such that time is of the essence for in-scope taxpayers that are still assessing systems and processes for GIR compliance for the 2024 year, the deadline for which is June 30, 2026.
• The recently enacted One Big Beautiful Bill Act (OBBBA) brought about certain changes that are particularly noteworthy as having each contributed to the U.S. tax system being accepted as a qualified SbS regime on the one hand, while perhaps warranting a watchful eye for continuing qualification of that system on the other.
• First, the removal of the qualified business asset investment (QBAI) substance-based exclusion to the calculation of global intangible low-taxed income (GILTI) of controlled foreign corporations (CFCs) attributable their U.S. shareholders significantly works to limit deferral of CFC earnings within a U.S. MNE group that might otherwise be eligible for participation exemption deduction upon a later repatriation of those earnings where there results instead a full inclusion of CFC earnings (no longer reduced by a substance-based exclusion) taxable currently at U.S. minimum rates now (through separate rate increase under OBBBA) comparable to that for Pillar Two. While determinations of GILTI (rebranded as net CFC tested income (NCTI) for post-2025 taxable years) remain based on U.S. tax principles and use a global blending approach (as opposed to a financial accounting base and more limited jurisdictional blending, respectively, for calculations of GMT under Pillar Two), GILTI is in many respects thought by many to be more restrictive in its application than the GMT (e.g., in being an annual calculation for which tax attributes such as CFC tested losses and attributable excess FTCs do not crossover to different taxable years) with the removal of QBAI (noting retention of a substance-based carveout for GMT purposes), inter alia, apparently enough to help foster an agreed broader consensus between IF members that the U.S. has an eligible worldwide tax system.
• Second, the similar removal of QBAI for purposes of calculating a foreign-derived intangible income (FDII) deduction (rebranded as foreign-derived deduction eligible income (FDDEI) deduction for post-2025 taxable years) for qualifying export activities of domestic C corporations has the inverse effect from that for QBAI removal for GILTI in reducing U.S. domestic taxable income for an anticipated even greater number of eligible taxpayers that had not previously benefitted from a FDII deduction while further increasing the benefit for eligible taxpayers that had historically benefitted from the deduction. While the OBBBA also provides for a reduced deduction percentage on FDDEI (resulting in a change in ETR from 13.125% to 14% on eligible income which draws closer to the 15% minimum rate for Pillar Two), a separate enacted law change that limits expense allocation and apportionment in the calculation of FDDEI to only those expenses which are “properly allocable to such gross income” (specifically excluding interest and R&D expense) has the effect of preserving more income taxable at a lower 14% FDDEI rate. With additional changes under the OBBBA that reinstate each a more taxpayer favorable business interest expense deductibility limitation and immediate expensing for domestic research and experimental expenditures, taken together with available R&D credits and certain production-based credits that might now benefit from a substance-based tax incentives safe harbor included in the Side-by-Side Package (see more below), it’s conceivable that U.S. MNEs under the right set of facts could potentially drive ETR on their domestic profits considerably lower than the 15% minimum rate under Pillar Two and potentially into the single digits. However, such a situation might be more the exception than the norm, with the U.S.’ domestic tax system on balance not thought to present a material risk that domestic profits be subject to an ETR of less than 15% (and, where occasion exists that ETR falls below a 15% rate, that more likely the result of available SBTIs which in proper alignment with the GMT under Pillar Two) in likely withstanding any future challenges to its status as a qualified SbS regime.

UPE safe harbor

The UPE safe harbor effectively makes permanent the transitional UTPR safe harbor. The transitional UTPR safe harbor shielded UPE jurisdictions’ income from being subject to the UTPR top-up tax if the jurisdiction had a statutory nominal corporate income tax rate that equals or exceeds 20% for fiscal years beginning in 2024 and 2025 (the first year the UTPR was generally in effect). The UPE safe harbor generally will be available to MNE groups whose UPE jurisdiction has a qualified UPE regime (i.e., a regime that is an eligible domestic tax system as described above) with such regime having been enacted and generally in effect as of Jan. 1, 2026 (however, the IF will accept requests to assess eligibility for prospective tax system changes put into effect if requested before 2029). Similar to the SbS safe harbor, if the IF determines a jurisdiction has a qualified UPE regime, it will be listed in the central record.

Baker Tilly observation:

• Currently, no jurisdiction has been identified by the IF as having a qualified UPE regime. MNE groups hoping to rely on this safe harbor starting in 2026 should monitor the central record for further developments.

Substance-based tax incentives (SBTI)

SBTI safe harbor

The SBTI safe harbor is available for fiscal years beginning on or after Jan. 1, 2026, and provides relief for any top-up taxes that would have been due by reason of QTIs, the definition of which includes both expenditure-based and certain production-based incentives. The GMT achieves this by way of a jurisdictional ETR adjustment, specifically by increasing covered taxes (the numerator of the ETR calculation). This ETR adjustment is limited to a substance-based cap, which is calculated as either:

• 5.5% multiplied by the greater of either a) eligible payroll or b) depreciation and depletion expense attributable to eligible tangible assets recorded in financial accounting net income or loss (FANIL), or
• 1% multiplied by the carrying value of eligible tangible assets

For QRTCs and marketable transferable tax credits (MTTCs) also qualifying as QTIs, MNE groups can elect to treat them as so and exclude them from the denominator of the jurisdictional ETR calculation to the extent of the substance-based cap described above.

Baker Tilly observation:

• The introduction of the new SBTI safe harbor could prove greatly significant for U.S. subsidiaries or permanent establishments of foreign-parented MNE groups in excepting from GMT imposition otherwise undertaxed profits in the U.S. from an implementing jurisdiction’s IIR or UTPR, which could occur in cases where U.S. constituent entities’ ETR falls below the 15% minimum rate due to, for example, the application of U.S. R&D and/or certain other production-based credits that are not treated as QRTCs for GloBE calculation purposes. Separately, U.S. MNE and foreign-parented MNE groups alike are expected to benefit from the introduction of the SBTI safe harbor as it is anticipated that a number of implementing jurisdictions may be “rethinking” their incentive programs in order to attract inbound investment through the use of qualifying SBTIs as such incentives would not negatively impact the GloBE calculation resulting in the imposition of the GMT. This in turn might necessitate active monitoring for new incentives that might come online in relevant jurisdictions in optimizing overall global ETR management for a given MNE group.

Material simplifications

Simplified ETR safe harbor

The simplified ETR safe harbor was introduced in the Side-by-Side Package to eventually replace and make permanent the transitional CbCR safe harbor as well as to assuage concerns in the global business community over the compliance burden (cost and effort) of applying the GMT. The simplified ETR safe harbor will deem any top-up tax to be zero in a jurisdiction where the simplified ETR equals or exceeds 15% and allows MNE groups to determine the simplified ETR using minimally adjusted consolidated financial statements (and other existing reporting packages) to determine jurisdictional ETR rather than calculate ETR on a constituent entity basis as required under the full GloBE rules (or by relying on CbCR data as currently required under the transitional safe harbor). The calculation of simplified ETR is generally simplified taxes divided by simplified income; however, simplified income and simplified taxes are calculated with adjustments that depend on financial accounting standards employed, transactional activity (such as mergers and acquisitions) engaged in, and other facts and circumstances as called for under the guidance. The simplified ETR is required to be made available for all fiscal years beginning on or after Dec. 31, 2026 (e.g., calendar year 2027) though some jurisdictions may be able to adopt as early as fiscal years beginning on or after Dec. 31, 2025 (e.g., calendar year 2026), if certain conditions are met.

Baker Tilly observations:

• It is anticipated that a large number of in-scope taxpayers might have preference for continued use of the transitional CbCR safe harbor over the simplified ETR safe harbor in years the safe harbors overlap (i.e., 2026 where there exists early adoption of the simplified ETR safe harbor and 2027 with the additional one-year extension of the transitional CbCR safe harbor as applicable). Upon expiration of the transitional CbCR safe harbor starting for 2028, in-scope taxpayers might still opt for a full GloBE calculation in the first instance if it is anticipated that constituent entities in a given jurisdiction might come in and out of qualification under the simplified ETR safe harbor across reporting years. As such, making the election under the simplified ETR safe harbor may be most optimal in cases where MNE groups have constituent entities in jurisdictions having minimum ETRs decidedly higher than 15%.
• As noted above, the simplified ETR calculation includes several required adjustments, caveats and special rules, meaning that depending on each MNE group’s profile, this provided simplification may have arguably missed the mark. In-scope MNE groups should review the guidance along with its facts to determine the viability of this safe harbor.
• As with the SbS safe harbor, in-scope MNE groups should monitor the local implementation status with respect to each jurisdiction in which they operate to determine effective dates and any jurisdiction-specific associated compliance requirements.

Extension of the transitional CbCR safe harbor

To accommodate the introduction of the simplified ETR safe harbor, the IF has extended the applicability of the transitional CbCR safe harbor to fiscal years beginning on or after Dec. 31, 2027, but ending before July 1, 2029. For purposes of the simplified ETR test (under the transitional safe harbor), the simplified ETR must equal or exceed 17% (the transition rate) for fiscal years beginning in 2027.

Other future simplifications

The IF is working on future simplifications with regards to:

• Permanent safe harbors similar to the routine profits and de minimis tests included under the transitional CbCR safe harbor
• Further simplification for instances where a MNE group may qualify for a safe harbor but perhaps not qualify in an interim period
• Integrating the simplified calculations as set forth in the simplified ETR safe harbor into the GloBE rules, and
• Streamlining of reporting obligations as well as adjusting the GIR and the GIR XML schema and validation rules as it relates to the safe harbors introduced

Conclusion

The provided safe harbors and simplifications offered in the Side-by-Side Package are welcomed. In-scope MNE groups, particularly MNE groups with U.S. UPEs that plan on utilizing the SbS safe harbor, need to exercise continued care in understanding this new IF guidance and monitoring for local jurisdiction implementation status, ongoing GIR compliance needs, and any other local filing requirements that might arise. Further, amidst an increasingly dynamic and often volatile geopolitical environment, there remains a distinct possibility that countries might selectively delay (or even forgo) their respective implementation efforts even if faced with the prospect of further counter measures on the U.S.’ part (e.g., reintroduction of the previously proposed section 899 “revenge tax” for potential passage into U.S. law), thereby raising uncertainty as to the extent of (and timing for) real relief ultimately being made available through local law enactment of this latest guidance.

Baker Tilly’s tax professionals will continue to monitor the situation, providing timely updates and strategic insight. If you have questions on how this may impact your tax situation, please contact your Baker Tilly tax advisor.