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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.

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