WHY ARE SOURCE RULES NEEDED?

Source rules are important for foreign nonresidents because they are taxed only on domestic-source income. In the case of nonresidents, the definition of source therefore controls taxation in the source country. Source rules might seem to be unimportant for residents, because residents of global jurisdictions are taxed on all income from whatever source derived. However, in practice, source rules are almost as important to residents as they are to nonresidents.

Source rules are a wonderful thing for lawyers and something that causes economists to despair. Contrary to the opinion of the Seligman commission in the 1920s, most tax economists today believe that income does not have a single source that can be pinpointed. Economists argue that defining the true economic source of income is almost impossible, because income has contributions from many countries. The determination of true source is relatively simple in a few isolated circumstances, including income from mineral deposits (sourced where the mineral deposits are located) or rent from a building (sourced where the building is located). However, defining the correct economic source is quite difficult if the business is more complicated or crosses borders.

Economists generally would prefer a world without any kind of source-based taxation at all. If you imagine a world in which each country taxes only its own residents (assuming for a moment you can agree on what is the definition of a resident to avoid dual-residency problems), defining source becomes unnecessary.