Inbound taxation: active income
Active (business) income is supposed to be taxed at source based on the benefits principle. However, from the 1930s it became clear that some minimal threshold of presence in the source jurisdiction is required to justify source-based taxation, because otherwise isolated sales into a country could subject a taxpayer to the costs of preparing and filing a tax return, which in that situation could exceed the income from the transaction.
Thus, from the mid-1930s on, two thresholds generally have been used. Under a country’s statutory law, where no treaty is applicable, the threshold is whether the taxpayer has a trade or business (TB) in the taxing jurisdiction. Where a treaty applies, the threshold is whether the taxpayer has a permanent establishment (PE) in the taxing jurisdiction. In general, the PE threshold is higher than the TB threshold. Both, however, require a physical presence (directly or through an agent) in the source jurisdiction, and in the age of electronic commerce this rule may pose a significant impediment to source-based taxation of active income. This is why the EU is currently debating replacing the PE threshold with a “digital PE” for corporations engaged in electronic commerce.
In addition, because a taxpayer that has a TB or PE in a source country can be audited, a question arises whether in that situation all of the taxpayer’s income from that country, including passive income (which ordinarily would be taxed on a gross-income basis under withholding tax rules), should be taxed...
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