OECD publishes ‘Side-by-Side’ Package on Pillar Two

The Simplified ETR Safe Harbour can be elected per “Tested Jurisdiction” in which an MNE Group is active. The concept of a Tested Jurisdiction does not fully overlap with territorial tax jurisdictions, but considers a group of Constituent Entities for which a separate ETR is calculated (e.g. JV Groups and Minority-owned sub-groups). This is similar to existing concepts under the main GloBE Rules. Save exceptions, Investment Entities, Stateless Entities, and Excluded Entities (the latter, because of their generally excluded status) would not be in scope of this new safe harbour. The safe harbour might also not be available in case an “eligible distribution tax system” election has been made in a Tested Jurisdiction. 

In general, the Simplified ETR Safe Harbour will be available for a Tested Jurisdiction if the relevant Tested Jurisdiction has not been liable to Top-up Tax in any of the FYs preceding the two-year period before the start of the FY in which the application of the Simplified ETR Safe Harbour is requested.

Failure to pass the Simplified ETR test in a given year is not prohibitive: the Simplified ETR Safe Harbour would subsequently be available again under the same conditions as above (i.e., if for two FYs after the failing year the MNE Group does not have a Top-up Tax liability in the Tested Jurisdiction under either the GloBE Rules or a “Specified Safe Harbour” (the only safe harbour that qualifies as such for now seems to be the “Simplified Calculation Safe Harbour for Non-Material Constituent Entities”).

The starting point to determine the Simplified Income are the financial data used to prepare consolidated accounts. However, for jurisdictions in which QDMTT is computed based on a local financial accounting standard, the latter should be used also for the Simplified ETR Safe Harbour. The OECD nevertheless encourages such jurisdictions to also allow computations based on the accounting standard used for consolidation purposes.

The Simplified Income is the Jurisdictional Profit (or Loss) before Income Tax of the Constituent Entities in a Tested Jurisdiction (generally the aggregated Financial Accounting Net Income or Loss (FANIL) increased with the aggregated income tax) adjusted by the following:

• “Basic Adjustments”. Excluded Dividends and Excluded Equity Gains or Losses (i.e., importing the Pillar Two participation exemption) are deducted and penalties, fines and illegal payments are added back to the FANIL.
• “Industry Adjustments”. There are specific rules for the financial services industry (for insurance companies and in respect of payments linked to additional or restricted tier one capital) and the shipping industry.
• “Conditional Adjustments for certain Equity-reported items of income”.
• “Optional Adjustments” including inter alia adjustments in line with the GloBE elections and an “M&A Simplification” providing for an exception to the reversal of income or expense attributable to Purchase Price Allocation accounting if all of the assets (except goodwill) and liabilities have the same tax basis before and after the M&A Transaction.
• “Mandatory Adjustments” in line with certain GloBE rules, where in some cases it can be elected not to apply such adjustment (e.g. the adjustment for an Asymmetric Foreign Exchange Currency Gain or Loss).

The Simplified ETR Safe Harbour also contains Transfer Pricing (TP) related adjustments:

• TP adjustments made after the end of the FY are generally to be taken into account in the year in which they are made rather than the year in which the transaction took place. The same would apply to TP-related adjustments to Covered Taxes. By exception, an MNE Group may exercise a five-year election to book the adjustment in the transaction year if the TP adjustment takes place within 12 months of the end of the transaction year (i.e., the year to which the TP adjustment relates).
• As regards transactions recorded at cost, the seller shall recognize an adjustment to reflect an arm’s length price (as used to determine taxable income) and the buyer should maintain assets at carrying value and recast deferred tax expenses at 15%. However, transactions concerning intangibles must always be adjusted to reflect an arm’s length price.
• Transactions between Constituent Entities in the same Tested Jurisdiction are only subject to the abovementioned TP adjustment rules if the sale or transfer has generated a loss.

The starting point of the Simplified Taxes is the Jurisdictional Income Tax Expense, being the sum of (i) current and deferred income tax expense/attributes included in the FANIL (i.e., in the financial accounts serving as starting point for the Simplified Income as well) of the Constituent Entities of the Tested Jurisdiction and (ii) deferred taxes recorded in the consolidated accounts that can be reliably attributed to such Constituent Entities.

The following adjustments apply:

• Elimination of non-Covered Taxes and factoring in of tax refunds and tax credits.
• Exclusion of tax expenses related to income other than Simplified Income.
• Exclusion of uncertain taxes and taxes not expected to be paid within three years, similar to what is foreseen under the main GloBE Rules.
• Certain adjustments are made to deferred tax expenses, notably a (simplified) recast at the minimum rate and the elimination of the impact of valuation allowances and accounting recognition adjustments. This also shows similarities with the main GloBE Rules but generally excluding deferred tax liabilities that are not Recapture Exception Accruals.

For loss years, to prevent triggering potential Top-up Tax exposure because of “excess negative taxes”, MNE Groups could apply the “Simplified Adjustment for Negative Taxes” that works similarly to the “Excess Negative Tax Carry Forward” under the main GloBE Rules. Alternatively, MNE Groups may opt for a “Loss DTA Adjustment” during a five-year transitional period following the first year of application of the main GloBE Rules or of the Simplified ETR Safe Harbour to the MNE Group in the relevant Tested Jurisdiction. The GloBE Loss election (under the main GloBE Rules) also remains available upon election.

MNE Groups may elect on an annual basis to include in the Simplified Taxes other Covered Taxes that are booked as expense but not as an income tax expense. Other optional adjustments to the Simplified Taxes are also included, among which the election in relation to newly introduced Substance-based Tax Incentives (see below).

As regards adjustments to taxes after the end of the relevant FY (i.e., true-ups in the financial statements for the next year), adjustments are generally to be taken into account in the year in which they are reflected in the financial statements. However, under a five-year election, the MNE Group may decide to take into account such adjustments in the year of the transactions giving rise to the tax adjustment if the adjustment is made within 12 months of the end of the transaction year. Such an election is to be made on a global basis (i.e., not Tested Jurisdiction by Tested Jurisdiction). A second derogation to the general rule applies in case of an a posteriori reduction of Covered Taxes of a prior year that would result in the Simplified ETR falling below the 15% minimum rate. In such case, the adjustment must be allocated to that prior year (and more complex GloBE computations may be required if the Simplified ETR Safe Harbour is eventually not available for the prior fiscal year), except under certain conditions.

In presence of a permanent establishment (PE) or a “Flow-Through Entity”, MNE Groups should generally follow QDMTT rules for allocating Simplified Income and Taxes across jurisdictions. However, taxes paid by a Main Entity on income attributable to a PE or taxes paid by a constituent-entity owner on income of a Flow-Through Entity subsidiary must in principle be excluded from both jurisdictions’ ETR calculations, except for withholding taxes on distributions. To avoid this potentially negative effect on the Simplified ETR, MNE Groups may also make a group-wide five-year election to apply certain cross-border tax reallocation rules (under articles 4.3.2 and 4.3.3 of the main GloBE Rules).

In relation to PEs of Main Entities that adopted anti-hybrid rules and have a taxable branch regime, an MNE Group may make the PE Simplification Election. This election allows groups to include the PE’s income and related taxes in the Main Entity’s jurisdiction’s Simplified ETR calculation, simplifying compliance.

QTIs are tax incentives reducing the current or future liability for a Covered Tax while being expenditure-based or production-based and generally available. Below, we further breakdown each of these elements.

• Covered Taxes: This means that tax incentives such as wage tax incentives do not qualify as QTIs. Similarly, subsidies or grants do not qualify as QTIs. Since such subsidies or grants are typically accounted for as income for accounting purposes, the treatment of a tax incentive as a QTI can, under circumstances, be more beneficial than receiving a grant or subsidy.
• Expenditure-based tax incentives: QTIs are not limited to a particular type of expenditure incurred or the form in which such expenditure-based tax incentive is provided (e.g., super deduction or credit of tax liability). It is however key that the incentive is directly linked to the expenditure incurred. Furthermore, tax incentives that only give rise to temporary differences do not qualify as QTIs. A QTI does not arise if the tax incentive exceeds the expenses incurred.
• Production-based tax incentives: Production-based tax incentives only qualify as QTIs when calculated based on the volume (i.e. not value) of the production of tangible property in the jurisdiction. A definition of eligible tangible property in this respect seems to be missing but seems to include clean energy.
• Generally available: Tax incentives only available to a specific group of taxpayers do not qualify as QTIs. However, the fact that an incentive is only available upon a decision of the (tax) authorities would, in itself, not prevent the tax incentive from qualifying as a QTI.

It is not necessary for the expenditure to be incurred or the production to occur in the same period as the amount of incentive was determined. However, expenditures or production made before the incentive was in effect are not eligible for QTI treatment. The incentive may, however, be used/available in years after the expenditure or production was made, subject to the aforementioned limitation.

The actual benefit under the Substance-based Tax Incentives Safe Harbour is capped by the lower of the QTI used and the Substance Cap.

The Substance Cap builds upon definitions used for purposes of the Substance Based Income Exclusion. It links to the Eligible Payroll Costs or depreciation or depletion expenses in respect of Eligible Tangible Assets. It means that taxpayers operating in the mobile asset industry (such as the shipping or airline industry) arguably can make limited use of this safe harbour.

The Substance Cap can be based on two methods:

• Under the first method, the Substance Cap is equal to the greater of 5.5% of the Eligible Payroll Costs or depreciation or depletion expenses in respect of Eligible Tangible Assets.
• Under the second alternative method, the Substance Cap is based on 1% of the carrying value of Eligible Tangible Assets (excluding land and non-depreciable assets). In order to use this method, a Filing Constituent Entity has to make a five-year election.

When elected, this safe harbour comes into play after the ETR in a Tested Jurisdiction is determined providing a reduction for the Top-up Tax corresponding to the QTI. It effectively results in a Top-up Tax based on an ETR calculation for the relevant jurisdiction where the QTI is treated as an increase to the Adjusted Covered Taxes.

The GloBE Information Return (GIR) should be amended to facilitate for this safe harbour.

Where a tax incentive qualifies as both a QRTC / MTTC and a QTI, a MNE Group may make an annual election to treat (part of) that tax credit as a QTI instead of a QRTC or MTTC. This can be elected per QRTC / MTTC and also does not necessarily hold for the entire amount of such QRTC / MTTC.

This seems favourable where the jurisdiction has significant payroll or tangible assets, resulting in a high Substance Cap, or where the QRTC / MTTC is substantial such that the GloBE ETR would fall below 15% as a result of the tax incentive. If, on the other hand, the Substance Cap is low or the jurisdictional ETR is already above the minimum tax rate of 15%, the administrative effort of electing for a QTI may not outweigh the benefit.

Under the SbS Safe Harbour, an MNE Group whose UPE is located in a jurisdiction with a Qualified SbS Regime may elect to have its Top-up Tax deemed to be zero for purposes of both the IIR and UTPR. This election applies groupwide: once available, it covers all domestic and foreign operations, including Joint Ventures and JV Subsidiaries.

A jurisdiction qualifies as having a Qualified SbS Regime where it meets the following cumulative criteria:

• An eligible domestic tax system, which includes:
• a statutory corporate income tax rate of at least 20% (after preferential adjustments and subnational corporate income taxes);
• a QDMTT or corporate alternative minimum tax at a nominal rate of at least 15%; and
• no material risk that in-scope MNEs will face an effective tax rate below 15% on domestic operations.
• An eligible worldwide tax system, which includes:
• a comprehensive foreign income inclusion regime covering both active and passive CFC and branch income;
• substantial unilateral mechanisms to address BEPS risks; and
• no material risk that in-scope MNEs will face an effective tax rate below 15% on foreign operations.
• A foreign tax credit for QDMTTs, available on the same terms as creditable Covered Taxes.
• Enactment timing: the domestic and worldwide regimes must have been enacted before 1 January 2026 (or a later date permitted under the IF’s review process).

Jurisdictions meeting these criteria will be listed in a Central Record of jurisdictions with a Qualified SbS Regime maintained by the IF. The U.S. meets these criteria and is already included in the Central Record.

Although the criteria are drafted in such manner as to allow other jurisdictions to hypothetically also avail of a Qualified SbS Regime, it remains unclear at this stage whether additional jurisdictions will in fact meet the criteria. Jurisdictions can request the IF to assess the eligibility of their tax regime as Qualified SbS Regime.

For MNEs with a UPE located in a jurisdiction that meets the domestic requirements but not the worldwide criteria of the SbS Safe Harbour, the Package provides a separate UPE Safe Harbour. This safe harbour applies to jurisdictions with a so-called ‘Qualified UPE Regime’. In such cases, the Top-up Tax under the UTPR for the UPE jurisdiction is deemed to be zero.

A jurisdiction qualifies as having a Qualified UPE Regime where it meets the following criteria:

• An eligible domestic tax system, in line with the requirements mentioned above.
• Enactment timing: the eligible domestic system must have been enacted and in effect as at 1 January 2026.

Jurisdictions meeting these criteria can request the IF to assess the eligibility of its tax regime as Qualified UPE Regime. It is currently not clear which jurisdictions are expected to qualify as a Qualified UPE Regime. While the U.S. appears to meet the requirements, it already falls under the broader Qualified SbS Regime and would hence not need to rely on the UPE Safe Harbour.

Importantly, the Package clarifies that QDMTTs remain fully operative under both safe harbours. The SbS framework does not deem Top-up Tax to be zero for QDMTT purposes, and MNE Groups remain subject to domestic QDMTTs wherever applicable. QDMTTs also continue to be calculated without pushdown of taxes on CFCs or branches, consistent with existing GloBE guidance.

The SbS Safe Harbour and UPE Safe Harbour can be elected for FYs beginning on or after 1 January 2026, with implementing jurisdictions expected to give domestic legal effect to these rules from that date.

However, according to the Package, where constitutional or legislative constraints prevent immediate adoption of these safe harbours, the UTPR may continue to apply in the interim, even in relation to jurisdictions that ultimately have a Qualifed SbS or UPE Regime. It will therefore be important for MNE Groups to monitor when jurisdictions with GloBE Rules incorporate these new safe harbours into their domestic legislation.

This timing also means that MNE Groups which could, as of 2026 or later, benefit from the SbS or UPE Safe Harbour must apply the full GloBE Rules for FYs 2024 and 2025. Separately, If MNE Groups operate in jurisdictions that are unable to implement the safe harbour rules in time, they may still be subject to Top-up Tax under the IIR or UTPR, even if headquartered in a jurisdiction with a Qualified SbS or UPE Regime.

From a compliance perspective, MNEs electing the SbS or UPE Safe Harbour will continue to file the GloBE Information Return GIR, but with significantly reduced reporting obligations for the jurisdictions covered by a safe harbour.

• SbS Safe Harbour:
• Only the general section of the GIR must be completed for jurisdictions covered by the SbS Safe Harbour. No jurisdictional ETR calculations or detailed GloBE computations are required for those jurisdictions.
• Importantly, these simplifications do not affect QDMTT obligations. QDMTTs operate independently of the SbS framework, and even MNEs with their UPE located in a jurisdiction with a Qualified SbS Regime must still complete the relevant GIR sections for QDMTT purposes, including the jurisdictional section and ETR calculation for each QDMTT jurisdiction.
• UPE Safe Harbour:
• Reporting is similarly reduced only for the UPE jurisdiction. Full GIR reporting remains required for all other jurisdictions.

While there is no official publication, the European Commission has previously voiced that the EU Pillar Two Directive would not require any amendment, meaning that the Package could be applied directly in all EU Member States. The European Commission seems to base its position on a provision in the EU Pillar Two Directive that refers to safe harbour rules developed after the adoption of the EU Pillar Two Directive. This provision (Article 32) prescribes that EU Member States apply the safe harbour rules, which are defined as “an international set of rules and conditions to which all EU Member States have consented and which grants groups (…) the possibility of electing to benefit from one or more safe harbours for a jurisdiction”.

However, the view of the European Commission creates various complexities for MNEs and may not be followed by all EU Member States. The SbS Safe Harbour, UPE Safe Harbour and Substance-based Tax Incentives Safe Harbour fundamentally alter the MNEs in scope of the EU Pillar Two Directive, in a way that was not foreseen at the time upon the adoption in 2022. Such amendments would normally have required all EU Member States to act unanimously in the framework of the Council, after consulting the European Parliament. By using article 32 of the EU Pillar Two Directive for the implementation of the Package, the EU legislator is effectively allowing the IF to change the content of the EU Pillar Two Directive, without the requirements that normally apply to the EU legislator. This practice potentially infringes settled case law of the Court of Justice of the EU on delegation of powers (Meroni-doctrine, developed first in case C-9/56). Competitors in non-qualifying jurisdictions could invoke these arguments to eliminate benefits obtained by MNE Groups under the Package.  

Moreover, EU Member States do not necessarily agree with the view of the European Commission that no amendment is required. While the European Commission seems to be of the view that the EU Pillar Two Directive does not need any change, EU Member States might understand that their national laws would require amendments. This creates potential uncertainty and additional complexities on the implementation of the rules in the EU.

Several other legal issues should also be addressed. For example, it should be monitored that the SbS Safe Harbour and UPE Safe Harbour do not discriminate against certain MNEs, by creating requirements that can effectively only be met by certain dedicated jurisdictions (de facto discriminations). Another issue is that, if the SbS Safe Harbour and UPE Safe Harbour were found to constitute prohibited State Aid, EU Member States could be required to recover the tax advantage from benefiting MNEs, resulting in retroactive tax liabilities and significant legal uncertainty for those groups. Competitors in non-qualifying jurisdictions could invoke these arguments to eliminate benefits obtained by MNE Groups under the SbS Safe Harbour and UPE Safe Harbour.