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I. GENERAL QUESTIONS AND METHODS OF APPORTIONMENT

(a) BOOK-KEEPING AND ACCOUNTING REQUIREMENTS

Latvian fiscal law has no provisions as to how the books and accounts of taxable enterprises shall be kept. When, therefore, enterprises are being taxed on the basis of their accounts, the regularity of their books and documents is to be tested according to the rules of the Commercial Code and those of ordinary commercial practice.

Only companies need be assessed on the basis of their balance-sheet and accounts. Other enterprises are assessed on this basis only at their request; otherwise their profits will be determined by means of coefficients — that is, empirically (see page 289).

(b) METHODS OF ALLOCATION

The only methods of apportionment provided by the law and actually employed in Latvia are the method of separate accounting and the empirical method. Fractional apportionment is never used. We shall see below the circumstances in which one of the two methods employed is preferred to the other.

1. Method of Separate Accounting

Whatever method may be used to assess the profits that a foreign enterprise earns from its Latvian business, the basic rule is that tax must be assessed exclusively upon the profits that represent business done by branches and establishments situated in Latvia.

The method of separate accounting, however, is only compulsory in the case of enterprises belonging to companies, which, as we know, have to forward a copy of their balance-sheet when making their return. Other enterprises may choose between this method and the empirical method, which consists of applying a coefficient to turnover.

When a foreign enterprise is taxed on the basis of its separate accounts, it forwards along with its return a copy of the special balance-sheet and a copy of the balance-sheet of all operations of its Latvian establishments; it must also send the minutes of its general meeting, within a month thereof. These last two documents are required to check the special balance-sheet.

The data of this sheet will be compared with the separate accounts of the Latvian establishments and with the documents on which these accounts are drawn up. The usual rules for auditing accounts are observed, but special attention is paid to documents referring to business done with the foreign part of the enterprise, to make sure that the invoiced prices are normal and that no profits have been secretly transferred.

Care is taken to see not only that the various transactions were conducted under normal conditions, but that the net profits are those which would have been ascertained by the application to turnover of the coefficients resulting from the general scale fixed by the tax committees for the different kinds of enterprise.

However, if the net profits, though lower than those resulting from this latter method of calculation, correspond to bona-fide accounts and reflect the real results of the Latvian establishment, regarded as a separate enterprise, they are accepted as the basis of taxation.

2. Empirical Method

Taxable profits are assessed empirically in the following cases:

The empirical figure is reached by applying a certain coefficient to the enterprise’s turnover and corresponds to the net profit. Accordingly, when the taxable sum is determined empirically, no account is taken of the expenses deductible when the enterprise is assessed according to its accounts (see page 290).

The coefficient is fixed by the general tax committee on a scale which divides industrial enterprises into classes according to their kind and purpose (see page 289). Minimum and maximum profit percentages are fixed for each class and the tax committee selects the rate it thinks suited to the particular enterprise.

These rates, however, may be reduced to nothing if the taxpayer can satisfy the committee that his real profit is less than the figure resulting from the coefficient. The committee, too, may increase the percentage indefinitely if the latter does not seem to it to reflect the real results of the enterprise.

The turnover figure on which the calculation is based is determined from the accounts or is based on some assumed figure.

(c) APPORTIONMENT BETWEEN BRANCH AND PARENT ENTERPRISE

1. Apportionment of Gross Profit of Local Branch to Real Centre of Management abroad

The principle of Latvian law that the establishment or branch of a foreign enterprise in Latvia shall be taxed as if it were an independent concern means that all the profits of these establishments are taxable, but they alone.

Hence, no part of the profits of the establishment can be ascribed to the enterprise abroad; but, if part of the establishment’s profit is due to the activities and services of the parent enterprise, that share may be deducted from the taxable profit. It is on this ground that deduction is allowed of commissions, royalties and interest paid to the parent enterprise, provided that these payments correspond to what would normally have been paid to third parties and that the parent enterprise, when invoicing goods supplied to its Latvian branch, includes in the invoice the profits which would normally have been earned, had these goods been sold to third parties.

2. Apportionment of Expenses of Real Centre of Management to Branch

Interest Charges. — If the parent enterprise is to ascribe to its Latvian branch a part of its interest charges and if that interest is to be deductible from the profits taxable in Latvia, the debt must have been incurred in the interest of the branch or the yield of the loan made over to it. Such interest may be charged to the Latvian establishment in proportion to the benefit the establishment has derived from the borrowed capital.

General Overhead. — The above rule applies mutatis mutandis to general overhead. These expenses may be deducted from the Latvian profit if they were incurred on behalf of the establishment or if they were of benefit to it.

3. Apportionment of Net Profit of Branch to Deficitary Parent or of Parent to Deficitary Branch

Given the general principle for allocating gross profits, it follows that the results of the parent enterprise do not affect the sum taxable in Latvia, either when the parent is working at a loss and the Latvian establishment at a profit, or when the position is reversed. In the latter case, the accounts of the taxable establishment will, of course, be examined especially closely.

(d) APPORTIONMENT BETWEEN PARENT ENTERPRISE AND SUBSIDIARIES

Subsidiary companies have a legal existence apart from the companies which created them. Accordingly, subsidiaries organised in Latvia by foreign companies are taxable like any other Latvian company.

If it appears, however, that these subsidiaries are transferring their profits to the foreign enterprise on which they depend, their accounts may be corrected and, if essential to a fair assessment, their profits may even be computed empirically. This indeed is only in accordance with ordinary law.

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