What Does Source Income Mean?
Today we’re going to learn about “income source”.
Have you heard about territorial tax systems?
What it means, in theory, is that they only tax you on your locally sourced income.
By contrast, some countries will tax you on your worldwide income, meaning you pay tax on everything you make everywhere. (For the difference see taxation basis)
Most places will tax you on your local source income unless we are talking about tax heavens, zero tax countries like Bahamas or Cayman Islands, however, these are super rare.
However, there’s the catch.
What exactly do they mean when they say ‘’local source income’’?
This totally depends on the country. Some people believe that they will be taxed based on where their customers are, this is not completely true. In some cases, this will happen in some others it won’t.
Usually, there are a few basic principles they apply.
The first is called ‘’permanent establishments’’.
This is very broad, but we can think of it as a permanent place of business.
For example, if you have a team and an office that can be considered a permanent establishment if you have a store that can be considered a permanent establishment as well.
In some cases, even a person can be considered a permanent establishment – for example, you have a manager somewhere who is doing their work remotely. They can tax you in the country where your manager is, as well as in the country where your operations are. This is something to be very careful about.
Next thing to consider is something called the “operations test”.
This means that they are going to look for where your business operations take place. For example, you could have your employees in Hong Kong, they do all the work but your customers are from Australia. In this case, you will be taxed in Hong Kong because this is where your business is operating from.
So, things to consider when thinking about source income:
- Permanent establishments
- Where is the work taking place
- Capital gains – for real estate you will be taxed based on where the property is
- Royalties – you will be taxed based on where your customers are
- Interest – you will be taxed based on where is the person paying interests from
- Dividends – usually taxed based on where is it paid from.
Note, these might be taxed at both ends, something to investigate.
These would be the rules loosely, however, when thinking about taxation the best is to look into each situation closely and that’s how we will know which structure will suit your business the most.
We help clients legally reduce their tax through international tax planning, as well as help with company formations, bank account openings, residency, citizenship, and payment processing. Have a question you want answered? Book a consultation now!