The OECD’s Side-by-Side Package: Stabilizing Pillar Two or the Beginning of Fragmentation?
The global minimum tax was never going to be implemented without political compromise. What was unexpected, however, was how central that compromise would become to the future of the OECD/G20 Inclusive Framework itself. The OECD’s Side-by-Side Package, released on 5 January 2026, marks a decisive moment in the evolution of Pillar Two(GloBE)—one that raises fundamental questions about global tax harmonization, competitiveness, and the long-term credibility of multilateral tax cooperation. At its core, the side-by-side system reflects a political reality: the United States was never fully aligned with Pillar Two, yet remains too systemically important to exclude. The result is a carefully engineered coexistence between the OECD’s global minimum tax rules and the US international tax system.
Whether this coexistence stabilizes Pillar Two—or ultimately undermines it—remains an open question.
The Inclusive Framework and Pillar Two: The Architecture Behind the Compromise
The OECD/G20 Inclusive Framework on BEPS brings together over 140 jurisdictions to coordinate global tax standards. Its ambition is to reduce profit shifting, increase transparency, and ensure profits are taxed where economic activity occurs.
Pillar Two—the Global Anti-Base Erosion (GloBE) rules—is the Framework’s most far-reaching reform. It establishes a 15% global minimum effective corporate income tax for multinational enterprise (MNE) groups with consolidated revenues exceeding €750 million. Unlike traditional tax harmonization, Pillar Two works through top-up taxes, enforced via three interlocking mechanisms:
- Qualified Domestic Minimum Top-Up Taxes (QDMTTs)
- Income Inclusion Rule (IIR)
- Undertaxed Profits Rule (UTPR)
| Rule / Mechanism | Definition & Purpose |
| Qualified Domestic Minimum Top-Up Tax (QDMTT) | A domestic tax designed to ensure that multinational enterprises (MNEs) with operations in a jurisdiction pay at least the 15% global minimum effective tax rate on local profits. A QDMTT allows the host country to collect the top-up tax itself rather than ceding that taxing right to another jurisdiction under the IIR or UTPR. It preserves domestic taxing rights and ensures that profits earned within the jurisdiction reach the agreed minimum rate. |
| Income Inclusion Rule (IIR) | The primary enforcement rule of Pillar Two. Under the IIR, the jurisdiction of the ultimate parent entity of an MNE group can impose a top-up tax on low-taxed profits of foreign subsidiaries if those profits are taxed below the 15% minimum. The IIR ensures that low taxation in subsidiary jurisdictions does not eliminate global minimum tax obligations but shifts the taxing right to the parent’s country. |
| Undertaxed Profits Rule (UTPR) | The secondary / backstop rule of Pillar Two. The UTPR applies when an MNE group’s parent jurisdiction has not applied the IIR (for example, if it does not have IIR legislation). In that case, jurisdictions where the group operates may collect the missing top-up tax by making adjustments such as denying deductions or reallocating income, thereby ensuring the minimum tax is paid somewhere in the group’s footprint. |
In theory, this architecture ensures that low-tax outcomes are neutralized somewhere in the system. In practice, however, political economy matters—especially when the world’s largest economy declines to fully participate.
The Political Turning Point: The G7 Agreement of June 2025
In June 2025, members of the G7 reached a political agreement to grant an exemption to US-parented MNE groups from the scope of Pillar Two’s Income Inclusion Rule (IIR) and Undertaxed Profits Rule (UTPR). Under this “side-by-side” agreement, the US tax system would operate in parallel to Pillar Two rather than fully within it. This concession acknowledged two realities:
- US political opposition—particularly from the Trump administration—to adopting OECD-designed tax rules.
- The OECD’s recognition that the US already operates an international tax regime that, in many cases, produces effective tax rates equal to or higher than Pillar Two outcomes.
Crucially, the exemption applies only as long as the OECD Inclusive Framework judges that the US tax system poses “no material risk” of domestic effective tax rates falling below 15%. This condition transforms the agreement from a blanket carve-out into a conditional political truce.
From Political Agreement to Administrative Reality: The Side-by-Side Package
After months of technical negotiations, the OECD released a comprehensive Side-by-Side Package on 5 January 2026, alongside updated Administrative Guidance on the GloBE Model Rules. The Package implements the G7 agreement from 1 January 2026 and introduces a suite of safe harbours designed to reduce compliance burdens while preserving the integrity of the global minimum tax.
The Side-by-Side Package includes:
- A permanent simplified Effective Tax Rate (ETR) safe harbour
- A one-year extension of the transitional Country-by-Country Reporting (CbCR) safe harbour
- A substance-based tax incentive safe harbour
- A Side-by-Side (SbS) Safe Harbour
- An Ultimate Parent Entity (UPE) Safe Harbour
- A commitment to future stocktakes of the SbS and UPE safe harbours
Together, these measures represent the OECD’s most pragmatic recalibration of Pillar Two to date.
The Side-by-Side System Explained
The Side-by-Side (SbS) System introduces two new Pillar Two safe harbours. The first, the SbS Safe Harbour applies to MNE groups headquartered in jurisdictions that operate both eligible domestic and worldwide tax systems—currently, only the United States qualifies. When elected, the SbS SH sets the Top-Up Tax otherwise collectible under the IIR and UTPR to zero for the MNE group. In effect, US-parented groups are removed from the Pillar Two enforcement net at the group level. Importantly, this does not eliminate Pillar Two entirely. It merely shifts the system’s center of gravity.
The second, the UPE Safe Harbour applies where the UPE jurisdiction has an eligible domestic tax system but not an eligible worldwide system. When elected, it only sets the UTPR Top-Up Tax with respect to the UPE jurisdiction to zero. The IIR may still apply elsewhere in the group structure.
What the Side-by-Side Package Does Not Do
A critical point—often misunderstood—is what the side-by-side system does not change. Most notably, it does not affect the application of Qualified Domestic Minimum Top-Up Taxes (QDMTTs) or Domestic Minimum Top-Up Taxes (DMTTs). Host jurisdictions retain full authority to impose domestic top-up taxes on low-taxed profits within their borders. Nor does the Package override domestic compliance obligations. Registrations, filings, and payment deadlines remain in force. The safe harbours are not self-executing; each Inclusive Framework member must legislate them domestically according to its own legal processes and timelines.
The Strategic Importance of QDMTTs in a Side-by-Side World
In a system where US-parented groups are exempt from IIR and UTPR, QDMTTs become even more strategically significant. A Qualified Domestic Minimum Top-Up Tax allows jurisdictions—particularly developing countries—to ensure that profits earned locally are taxed up to the 15% minimum before taxing rights are ceded elsewhere. In the side-by-side context, QDMTTs represent one of the few remaining tools to anchor taxing rights domestically when group-level rules fall away. This has profound implications for:
- Special economic zones and free zones
- Tax incentive regimes
- Investment promotion strategies
Pure rate-based incentives are increasingly neutralized. The competitive frontier is shifting toward non-fiscal incentives, regulatory certainty, infrastructure quality, and governance credibility.
Stability or Fragmentation? Two Plausible Futures
One commentator has framed the side-by-side deal as pointing toward two plausible futures.
Scenario One: Ossification and Stability
In this scenario, the side-by-side arrangement survives the 2029 “evidence-based objective” review and hardens into a durable feature of the international tax system. Safe harbours become accepted limits on tax reform, providing certainty for MNEs and stability for governments. Under this outcome, Pillar Two does not collapse—it evolves into a pluralistic minimum tax system, accommodating different domestic models within agreed guardrails.
Scenario Two: Unravelling and Fragmentation
The alternative—and arguably more likely—scenario is one of continued instability. As other countries seek their own side-by-side-style arrangements, abandon domestic top-up taxes, or compete through increasingly creative incentives, Pillar Two risks fragmenting under the weight of its own complexity. In this future, the side-by-side deal accelerates—not prevents—the erosion of global minimum tax harmonization.
What This Means Going Forward
The OECD’s Side-by-Side Package is neither a technical footnote nor a temporary fix. It is a structural pivot in the global tax project.
For policymakers, investors, and development practitioners, the key question is no longer whether Pillar Two exists—but how unevenly it will apply, and what that unevenness means for competitiveness, sovereignty, and development outcomes. The side-by-side system buys time. Whether it ultimately buys stability—or merely postpones fragmentation—will depend on how governments use the space it creates.
For developing countries and special economic zones, the message is clear: the era of competing on tax rates alone is over. The future lies in building investment ecosystems that remain attractive even when tax arbitrage disappears. The global minimum tax may no longer be truly global—but it is reshaping the rules of the game nonetheless.
