The Origins of Destination-Based Income Taxation: Us and International Tax Perspectives

12 Pages Posted: 15 Oct 2022 Last revised: 8 Nov 2022

Date Written: September 28, 2022


Value added taxes are destination based, i.e., tax is imposed on imports and exports are zero rated (so that the exporter can receive a refund on VAT collected in previous stages of production). Income taxes, on the other hand, are typically origin based, i.e., imports are deductible and exports are taxed. However, from the very beginnings of the international tax regime, it was recognized that this treatment of income for tax purposes is unfair to destination countries which contribute to the profit created by the market. But the introduction of the permanent establishment (PE) threshold (which dates back to the Austria-Prussia tax treaty of 1889 and was included in the first League of Nations model of 1928) and the arm’s length standard (ALS) for dividing the income among related taxpayers (which dates to the 1930s) significantly limited the ability of destination countries to tax cross-border business income.

At the same time, the US states were developing the concept of formulary apportionment (FA) and from the beginning included sales in the formula, thereby giving the destination state the right to tax part of the business income of a corporation selling goods or services into the destination state with no PE or ALS limitation. Already in the early 1990s critics were arguing that FA including a sales factor (or even based entirely on a sales factor, as US states were increasingly tending to do) were a better alternative for international taxation than PE and the ALS. This critique became more important with the invention of the internet and the rise of the digital economy from 1995 on. By 2013, the OECD acknowledged that the digital economy presented a problem, and in Pillar One of BEPS 2.0 (2018-) provided a partial solution that discards the PE and ALS limits on Amount A (25% of the residual income of the largest multinationals).

The prospects of Pillar One are dim, however, because it requires a multilateral tax convention (MTC) to overcome the PE and ALS limits, and because the US is unlikely to join such a MTC, especially if other countries refuse to abandon gross-based digital services taxes (DSTs). Thus, in my opinion a better option is for destination countries to adopt Pillar One concepts unilaterally, as the US states have done and as India has proposed doing for international taxation.

Keywords: destination basis, Pillar One, BEPS

JEL Classification: H26

Suggested Citation

Avi-Yonah, Reuven S., The Origins of Destination-Based Income Taxation: Us and International Tax Perspectives (September 28, 2022). Available at SSRN: or

Reuven S. Avi-Yonah (Contact Author)

University of Michigan Law School ( email )

625 South State Street
Ann Arbor, MI 48109-1215
United States
734-647-4033 (Phone)

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