KPMG report: Pillar Two and tax incentives

Even when the local statutory corporate tax rate is 15% or higher, the effective tax rate (ETR) under the Pillar Two global anti-base erosion (GloBE) rules may be reduced due to the application of tax incentives under local law. The extent to which incentives affect the GloBE ETR depends on the incentive design as well as the fiscal year in which the incentives are utilized. At a high level, the extent of the effect can be summarized as follows:

• Incentives that create temporary book-to-tax differences (e.g., accelerated depreciation and immediate expensing) usually have no downward impact on the jurisdictional GloBE ETR, as these differences are ironed out under Pillar Two through deferred tax accounting, subject to the application of recapture rules.
• There will also not be a downward impact on the jurisdictional GloBE ETR for a broad range of expenditure-based and production-based incentives (e.g., refundable and non-refundable tax credits, enhanced allowances, and, in limited circumstances, reduced rates or income exemptions) to the extent substance in form of payroll costs or tangible assets is available in the jurisdiction. Notably, such favorable treatment will only be available from 2026 under the substance-based tax incentive (SBTI) safe harbor that was adopted by the OECD Inclusive Framework in January 2026 and that introduces significant changes to the way Pillar Two deals with incentives.
• Irrespective of the application of the SBTI safe harbor, grants, subsidies, and certain types of refundable and marketable tax credits generally have a low downward impact on the GloBE ETR by being treated as an increase to GloBE income (i.e., the denominator of the ETR formula) rather than a reduction in covered taxes (i.e., the numerator of the ETR formula).
• Other types of incentives that are calculated by reference to income or other parameters (e.g., equity increases) and that reduce the amount of covered taxes without a corresponding adjustment to GloBE income have a significant downward impact on the GloBE ETR.

The effect of an incentive available to certain entities in a jurisdiction may be further limited when the profits of other constituent entities (CEs) in the same jurisdiction are effectively taxed at higher rates (i.e., because they do not benefit from incentives). Due to the jurisdictional blending approach, a lower ETR of one CE may be offset by a higher ETR of other entities in the same jurisdiction. This will particularly be the case where the headline corporate tax rate is high.

When incentives reduce the jurisdictional GloBE ETR below the 15% minimum rate, a top-up tax may arise, partially offsetting the intended benefit of the incentive. At the same time, the Pillar Two framework provides for a number of measures that mitigate the top-up tax exposure of incentives:

• Top-up tax liability may be deemed to be zero based on a number of safe harbor provisions (e.g., side-by-side safe harbor (SbS) or the undertaxed profits rule (UTPR)/ultimate parent entity (UPE) safe harbor) regardless of how incentives affect the ETR under the full GloBE rules.
• The effect may also be further limited when the incentives focus on investments in tangible assets and labor to benefit from the substance-based income exclusion (SBIE). The SBIE reduces profits to which the top-up Tax rate applies by a markup on the carrying value of eligible tangible assets and eligible payroll costs. The resulting top-up tax amount will therefore be lower when the SBIE is high (i.e., when the value of assets and payroll are higher).

Read a May 2026 report prepared by KPMG International Ltd, in collaboration with KPMG’s EU Tax Centre that analyzes how the application of different types of tax incentives may trigger a potential Pillar Two exposure and how countries may be incentivized to adjust their tax system.