Question

Clario, S.A., a Peruvian corporation, manufactures furniture in Peru. It sells the furniture to independent distributors in the United States. Because title to the furniture passes to the purchasers in the United States, Clario reports $2,000,000 in U.S.-source income. Clario has no employees or operations in the United States related to its furniture business.

As a separate line of business, Clario buys and sells antique toys. Clario has a single employee operating a booth on weekends at a flea market in Waldo, Florida. The antique toy business generated $85,000 in net profits from U.S. sources during the current year.

What is Clario's effectively connected income for the current year?

Answer 1

Tax Liability arises on Source Based rule or Receipt Based Rule. Also the concept of Place of Effective Management decides the place of operation of Business and ultimately also decides the tax laiblity.

In the present case, Clario sells the furniture to independent distributors in US. And thus as per source based rule, it is deemed that income generated from such activity will be taxed in US. Therefore the income generated of $2000000 in US will be taxable for the current year in the US. But since the income will be received in Peru, such income will also be taxable in Peru as receipt based rule. Hence, there will be double taxation on the same income generated. To avoid such double taxation, Clario need to refer the Double Taxation Avoidance Agreement(DTAA) between the two countries.

Clario also buys and sell antique toys. And the same antique toys business generates $85000 of profits in US. The same way as per source based rule such income will be taxable in US. But since this income also will be received in Peru, such income will also be taxable in Peru as receipt based rule. Hence, there will be double taxation on the same income generated. To avoid such double taxation, Clario need to refer the Double Taxation Avoidance Agreement(DTAA) between the two countries.

However as of now we are considering both the income would be taxable in home country and total income for the current year would be $2085000. Please note that it is a case study based question which can had a different opinion based on the further information of Double Taxation Avoidance agreement.