74. It is clear that different methods will have to be applied for the various categories of enterprises. A careful study of the peculiarities of each separate enterprise will lead to a better understanding of the value of the various factors which contribute to the making of profits. Some of the factors which will always receive careful consideration in the course of the checking of the taxpayers’ returns are: the fact whether the activities of the business are industrial or agricultural, or exclusively buying and selling; the turnover; the analysis of the costs; the fixed capital and the fluid capital used in N.E.I.

75. Practically all the great industries producing raw material or staple products operate exclusively in N.E.I, and therefore raise no problems of apportionment. Problems arise, however, in the case of enterprises whose products for some reason or other have no regular quotation in the world market, and have to undergo more or less intensive treatment before being ready for consumption. Up to the present, it has been possible to arrive at a reasonable assessment by making a comparison with the proceeds from the sale of raw material by other enterprises, or by an estimate of the influence of the manufacturing process on the sale price. But the fact that many difficulties have to be faced cannot be denied. For instance, many point out that, as a result of increasing competition or of other causes, the organisation of the sales outside the N.E.I. territory is a factor of ever-growing importance for the making of profits. This makes it urgent to study more intensively the structure of the business, so as to be able to decide whether a part of the total profit may be attributed to this sales organisation, because of its having a permanent influence in making the profit.

76. Similar difficulties arise, when the producing department has been formed into a separate corporation, and the sales are entrusted to another company, which forms part of the same world concern. The relation between the sales corporation and that concern may be similar to that of a branch and a parent company, or it may be that the production and the sales corporations are both subsidiary companies of another company which holds their capital stock. When such is the case, the N.E.I. tax administration is naturally not tied to any juridical limits. Endeavours will have to be made to determine the profits realised by the company working in this country — i.e., the profits derived from the production of the raw material, and this, if necessary, independently of the data furnished by the parties interested. In some instances, it may be necessary to examine the results obtained by the entire composite body, so as to obtain a correct idea of the profits made in this country.

77. With regard to companies whose activities in N.E.I. are limited entirely to the buying of produce, the assessment of the profits offers many divergent points of view. In such cases, the books are often inconclusive, because the concern abroad looks upon the organisation in this country as only an item of expense, and does not recognise that buying as well as selling are factors in the making of profits. When the buying is carried on wholesale, there will often be arguments for fixing the gross profits at the same amount as the buying commission which would be paid to a third party. When there is an extensive organisation for buying transactions, a different procedure will have to be found for the determination of the Indian profits (see paragraphs 109 and 110).

78. It also occurs — and apparently these difficulties are found throughout the world — that the books and accounts of a branch, however complete and perfect, cannot be taken as the basis for the calculation of the profit derived in this country. This is the case, for example, when it is impossible to verify the invoicing of the head office or the branches abroad to the branch in this country. In these cases taxable income is estimated, as a rule, on the basis of a presumed yield at the prevailing rates of interest on the capital invested, or on the turnover. As this method does not assure accuracy, the results may be further verified by examining the invoices showing the cost to the head office or the branch shipping the goods to N.E.I.

1. Method of Separate Accounting

79. In general, the fiscal authorities start from the principle that the profit made by the N.E.I. part of the enterprise must be proved by the book-keeping carried on in this country. The annual statements sent in with returns, and containing the data for the so-called East Indian profits, will serve as a basis of assessment. This procedure is just; bona-fide taxpayers, who have arranged their book-keeping in such a way that it gives a clear insight into the profit made by the “branch”, need not have their entire book-keeping examined. Of course, the taxpayer may at all times be asked to give any information with regard to the book-keeping of the branch, its relation to the chief book-keeping and to that of other branches, the manner of invoicing, the calculation of compensation for services rendered by the other branches to the Indian branch. This procedure has also practical advantages, because the Company-Tax Ordinance imposes on the taxpayer an obligation the ignoring of which will place him in the position of a defaulter. The administration may then estimate the taxable income.

80. A considerable number of the enterprises working in N.E.I. are resident in the Netherlands. A few years ago a branch of the N.E.I. tax-accountancy service was instituted in the Netherlands; this enables the administration to examine the chief book-keeping of those bodies established in the Netherlands, with their consent. Up to the present, no objections have been raised by the taxpayers against this examination. It goes without saying that there is a perfect co-operation between the two services, the one in N.E.I., the other in the mother country. In a few instances, the N.E.I. authorities have examined the principal book-keeping of businesses established in other countries with the consent, of course, of the taxpayer.

2. Empirical Methods

81. When the book-keeping and other detailed evidence regarding the business in N.E.I. are insufficient, 50 that it is impossible to calculate the local profits on the basis thereof, some other method of allocation must be employed. Efforts are made to collect as much data as possible, so as to obtain a reasonable basis to start from. When the gross receipts, or turnover figures, are known (and, as a rule, they are), a gross profit may be computed by applying to the gross receipts a percentage based on data obtained from similar enterprises. From the gross profit thus estimated, the expenses of the local establishment are deducted in order to arrive at the taxable net profit. As a rule, valuation of the net profit with reference to gross receipts is not to be recommended, as this method is not exact enough, and is apt to neglect differences in costs of doing business in the various countries where the enterprise has branches. The book-keeping of the local branch should show the actual expenditures in N.E.I. The problem of the extent to which the general expenditure of the enterprise is deductible from the profits of the local branch is not be solved along general lines, but depends on the circumstances of the particular kind of business.

82. In certain cases it is assumed that a certain amount may be allowed for the buying office as buying commission, and that it should be equal to the usual buying commission paid to a third person. But this method has the drawback that profit is always attributed to the country where the buying is done, without taking into consideration the total results of the business. Hence, preference is given, on practical and theoretical grounds, to the method of expressing the N.E.I. profits as a fraction of the total profits.

3. Method of Fractional Apportionment

83. If the accounts of the head office show the total net profit of the foreign enterprise, an analysis of the structure of the activities of such an enterprise and of its possibilities for making profit in N.E.I., as compared with those in the other countries in which the enterprise operates, will indicate which part of the total profit should be taken as a minimum to represent the so-called N.E.I. profit. The fixing of this proportion may be facilitated by making a comparison with other enterprises. Another method is to take the net results of the entire enterprise as a basis and calculate how much should be allocated to the part of the enterprise abroad and therefore excluded from the assessment. In some cases, an apportionment of profit in accordance with the turnover figures will be the most practical method.

84. On the part of the taxpayers, repeated efforts have been made to arrive at an apportionment of profits on the basis of wages paid for labour performed in obtaining the profits. In order to have a reliable basis of comparison, it may be necessary to correct these figures, so as to take into account the difference in the wage standard prevailing in different countries. This reasoning is based on the thesis that the carrying on of a business consists of the organic use of the means of production — viz., labour, soil and capital; and that the two latter elements ought not be taken into consideration for the allotment of profits. The N.E.I. authorities have rejected, in principle, this basis for the apportionment of profits, and they have been upheld by the Court of Tax Appeals. The primary reasons for rejecting this basis are that the wage-scale varies so greatly from country to country that it cannot be taken as a common basis for comparing the profit-earning capacity of the branches in the different countries, and also that, in the case of many enterprises producing raw materials, their very life is due to the soil, climate and other circumstances peculiar to N.E.I. For example, this country in 1931 produced 90 per cent of the world supply of cinchona from which quinine is made, and the tobacco of Sumatra has a certain quality which is not found elsewhere.

85. It has therefore been definitely settled that the amount of wages paid out in the different countries cannot be taken as a basis for the apportionment of the profits. There remains the difficulty of selecting a guiding principle for apportionment. Happily, certain opinions are developing, and these are carefully watched, both by the taxpayer and the administration. For instance, for enterprises which buy at their head office in Europe and sell in N.E.I., the profits are apportioned in the ratio of 25 per cent to the buying office and 75 per cent to N.E.I. These figures may vary, however, for each individual concern.

86. The international trade in raw products offers particular difficulties, because it is frequently carried on by enterprises with their head office in Amsterdam, London, New York or elsewhere, and with purchasing branches in N.E.I., and selling branches in other countries. The N.E.I. branch is instructed by cable to make purchases, sometimes for subsequent sale abroad, sometimes to cover sales already made, sometimes for a mere speculation. It is often impossible to determine the results obtained by the various transactions, because buying and selling are intermingled in such a way that the value, or at any rate the result of each transaction, cannot be traced separately. And, even if the result could be traced, there remains the difficulty of deciding to whose initiative, or to which other activities, the profit derived from the buying or selling is to be attributed, and whether these factors are within or without N.E.I. The total or general results will have to be found in the annual accounts. In practice, the taxpayers have always shown great willingness in supplying the authorities with the information desired, and the profits are allocated as described under the heading “Buying Establishments” (paragraphs 109-114).

87. On the whole, the verification of general results should be restricted to a written explanation of the items in the annual accounts and written answers to certain questions about the system of valuation of stock, depreciation, overhead and running expenses, reserves, etc. Delicate questions are always presented by the manner in which the head office charges the local branch with supplies, services and overhead expenses. The examination of the principal book-keeping is usually only possible in the case of Dutch companies operating in N.E.I. Although it must be admitted that this is an unsatisfactory state of affairs, it is plain that a satisfactory solution is hard to find.

88. Subsidiary companies of large concerns have sometimes caused difficulties when the annual statements of the parent company were subjected to a closer examination. The taxpayer argued that it is not necessary to examine the results of the other subsidiary companies abroad for the sake of verifying the profits of the subsidiary company here, once they have — in their opinion — provided sufficient data for the latter.

4. Requirements for the Selection of Methods and Value of the Various Methods

89. The Ordinances in force do not lay down any rules for the application of one or another method. The authorities have perfect liberty in selecting any method of apportionment. Foreign concerns may not demand the application of a certain method. However, as the Company-Tax Ordinance requires foreign concerns to keep their books in such a way as to show the East Indian profits, the authorities first examine the separate accounting. They will only deviate from this method when they find that the figures actually fail to show clearly the profits made by the enterprise in N.E.I., or when this method is precluded by the nature of the business. The Ordinance makes an exception only for insurance companies which may choose between separate accounting and fractional apportionment (see paragraph 33).

90. It cannot be said positively which method is considered the most practical and satisfactory from the viewpoint of normal use and of prevention of tax evasion, because the circumstances of one concern will point to one method, and those of another concern to a different one, or even to a combination of various methods. Generally speaking, it may be stated that, for the great agricultural and mining concerns, it is possible to arrange their accountancy in this country in such a way that the figures give a clear idea of the financial results. At the same time, it will be necessary to verify the branch accounts in the light of annual accounts, invoices and compensation accounts of the head office, and, as a rule, this can easily be done. The export and import concerns present the real difficulties, and there is a growing tendency to fix the Indian profits at a certain portion of the total result.