#### Local Establishments selling in National Markets

102. When a foreign enterprise purchases goods abroad and sells them in N.E.I., it is exceedingly difficult to define what should be considered as the East Indian profit of the enterprise.

The administration prefers that goods purchased abroad be invoiced to the N.E.I. establishment at the original cost to the enterprise; the invoice price should therefore not include a part of head-office expenses or a part of the profits to be realised on sale here. The fiscal administration will determine the amount of the deduction to be allowed from the East Indian profit in respect of head-office expenses, and also the amount of the profit realised here which is to be allocated to the purchasing office as its profit.

If the invoice price is above original cost, the administration will require information as to the basis on which it is computed. Several companies send the original invoices showing the price they paid for the goods shipped to the East Indian offices, so that the examination of the book-keeping here gives a complete insight into the state of affairs. Nevertheless, there remains the problem of determining how much of the profit is to be allocated to the branch in this country.

103. It is not fair to start from the idea that all the profits are made on the selling, so that only the expenses of the establishments abroad are deducted. This conception prevailed here formerly, and found many adherents because of its simplicity in throwing the entire profit to the place of sale. Owing to a better insight into these matters, however, the principle of apportioning profits has been adopted.

As a rule, the buying of goods for importation into N.E.I. requires a good deal of experience and commercial judgment, especially when it involves an enormous variety of merchandise. A part of the profits should decidedly be allocated to this buying. For the greater number of import enterprises an allocation on the basis of 25 per cent for the buying and 75 per cent for the selling in this country may be accepted as fair and reasonable. Of course every taxpayer may prove that the circumstances of his own business justify a divergence from this standard.

When a monopoly article is involved, there is a tendency on the part of the fiscal authorities to allocate a larger part — for instance, 90 per cent — of the profits to East India. The reason for this is that, once the agency for these articles has been obtained, the buying is done more or less automatically, being limited chiefly to the passing on of orders from East India.

104. When the foreign company manufactures its own goods, the chief question is whether only a fraction of the output is sold in N.E.I. or whether the products are manufactured exclusively or primarily for sale in N.E.I. If only a part of the products are sold in N.E.I., the calculation of the “selling price” from the factory to the export department of the enterprise should be carefully examined. The price at which the export department invoices to the local sales branch is subject to the same verification as that described above in connection with an enterprise buying abroad for sale in East India. Furthermore, the authorities may request information as to the prices at which the same goods have been invoiced to dealers or branches in other countries, or, if necessary, they may make a comparison with the profits of local competitors. If a company has virtually a world monopoly of a given product which it markets itself, the taxpayer often fixes the East Indian profits at a certain percentage of the selling price, which may be accepted by the tax authorities after a careful examination of the accounts.

105. When a manufacturing company produces articles especially for N.E.I., it usually markets them here itself through a sales branch, or through a subsidiary company, which, in fact, is nothing more than a sales department of the company. In this case, the profits realised should be fixed at a fraction of the total net profits, and it seems just to allocate to each of the two parts of the enterprise one-half of the profits, although here, also, the particular nature of the business may justify a different percentage. Usually, the taxpayer will show a tendency to put a lower value on the sales profits, and a higher one on the manufacturing profits. On the contrary, the authorities are inclined to put a considerably higher value on the sales. This tendency is the result of the economic development of these recent years, during which sales have become a factor of paramount importance in view of the widespread over-production.

If the sales branch in N.E.I. markets not only goods which have been manufactured by the foreign enterprise, but also goods which have been purchased (for example, to complete its line), the authorities would attempt to segregate the two categories and allocate the profits of each in accordance with what has been said above.

106. Although the establishments referred to here are of rare occurrence, the N.E.I. administration looks upon the activities of the branch established in this country which sells its goods in a third country, where the parent company has no permanent establishment, as selling transactions carried out in this country. If the head office established abroad is able to prove that the sales in neighbouring countries should be attributed entirely or partly to its activities, the administration would take these circumstances into consideration in fixing the profits of the local branch.

#### 2. Manufacturing Establishments

107. In the case of agricultural enterprises, the production of the raw material entails, as a rule, considerable manufacturing processes, and for the finished “raw” product universal market prices exist. The same is true of the products of mining enterprises in N.E.I. Consequently, when a foreign enterprise produces the raw material here and sells it on any of the world exchanges, the entire profit is regarded as taxable in N.E.I. If the foreign enterprise uses its raw material in manufacturing at a factory in another country, the world market price for the raw material is used to delimit the profit allocable to N.E.I. However, N.E.I. is not a real industrial country, so that this question of determining manufacturing profits is of no practical importance here. As the wage standard for the native labourer is very low, it is not at all impossible that eventually more and more industries will be established here. There can be no doubt that, in this case, a profit would be allocated to the local manufacturing establishment in accordance with the same principles as are applied in apportioning profits between a foreign manufacturing establishment and a local sales establishment (see paragraphs 104 and 105).

#### 3. Processing Establishments

108. Processing establishments have seldom, if ever, come to the attention of the fiscal administration. In principle, however, if materials have undergone some kind of manufacturing process in this country, a certain part of the net profit will be allocated to the establishment where the processing took place.

111. Difficulties arise especially when the enterprise does not confine itself to real buying and selling of products, but goes in for speculative transactions. The verification of the allocation of profits as made by the taxpayers themselves (for instance, for the purpose of calculating a bonus to the East Indian manager or staff) is exceedingly difficult in those cases, because it is generally impossible to trace the results of certain transactions, on account of the impossibility of putting purchases over against corresponding sales. As a last resort, the East Indian profit will have to be computed by means of valuation.

112. As a general rule, we may say that, for foreign concerns, which carry on wholesale buying in this country of products of industries, which products are again sold wholesale abroad, the profits are considered to have been made in the ratio of 50 per cent within and 50 per cent outside N.E.I. This method of apportionment is applied to the total net profit derived from the transactions carried on partly within and partly without the country, without taking cognisance of any specific commissions or charges made by establishments abroad against the buying establishment within N.E.I. as compensation for sales activities, management or other services rendered to it. The application of this method is, of course, subject to modifications in order to take into account the particular circumstances of a specified enterprise.

113. When the products have to undergo some sort of manufacturing process in N.E.I., the nature of this process will be the deciding factor in determining whether more than 50 per cent is to be allocated to this country. In one case1 the taxpayer, a foreign company purchasing and preparing tobacco in N.E.I., had valued its local profits at half of the total net profits. Seeing that the business of this taxpayer consisted in buying within N.E.I. territory wet and half-dried tobacco, curing such tobacco, packing and exporting the finished product and selling it wholesale in Europe, the fiscal authorities moved that even the entire profit might be considered as East Indian profit. The Court of Tax Appeals, however, judged that, as the principal management for the buying, all the selling and the general financial management and the book-keeping were established in Europe, all of which were doing work of considerable influence in the making of profits, it would be a fair division to regard two-thirds of the net profit as East Indian profit.

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114. On the other hand, it will be inadmissible to fix the East Indian profit at half of the net results of the foreign enterprise if the latter subjects these products, bought wholesale, to an additional manufacturing process in the foreign country, or sells them to the public at its own retail establishments. In such cases a certain part of the profits must be allocated either to the manufacturing process or to the retail sales.

#### 5. Research or Statistical Establishments, Display Rooms, etc

115. The mere existence of these establishments in N.E.I. presents, as a rule, no grounds for taxation, unless direct selling transactions take place on the premises. When a foreign corporation has a sales establishment in this country, it is felt that any profits attributable indirectly to the existence of a display room or a statistical establishment will appear in the books of the selling establishment, and, consequently, will be included in its assessment. Should it be necessary to determine the East Indian profit by fractional apportionment, the existence of such establishments would be considered as justification for increasing the East Indian proportion.

#### (b) BANKING ENTERPRISES

116. The problem of the allocation of profit in the banking business is exceedingly difficult, and opinions differ greatly. In practice, the banks working in this country maintain separate accounts reflecting the profits of the local branch, subject to correction by the authorities. Until now, practically no difficulties have arisen in connection with the allocation of items of gross income. Thus, the gross income of a N.E.I. branch includes income from lending to individuals or companies in N.E.I., discounting bills in N.E.I., effecting collections or rendering other services in N.E.I., as well as rents from property situated in N.E.I., and profits from a business conducted in N.E.I., The principal difficulty experienced relates to the allocation of deductible interest. No deduction is allowed for interest on the bank’s own capital, whether that capital is used by the head office or is used by the branch in N.E.I. or a branch elsewhere. On the contrary, interest on deposits is a deductible expense. It is the theory of the administration that the money from deposits becomes mingled with the capital of the bank itself, and therefore loses its character. The combined funds flow from one establishment of the bank to another in accordance with the need for it in making loans. When an establishment advances money to another, it charges interest. For tax purposes, however (or for purposes of determining the profitableness of the various establishments), only the interest on deposits is deductible. As it is impossible to ascertain how much of every advance is out of deposits and how much is not of capital, the authorities presume that the proportion of deposits to capital is the same in every part of the enterprise. Consequently, the tax authorities allow as a deduction from the East Indian profits the same proportion of interest paid here to depositors as total deposits bear to total capital.

117. The taxpayers frequently object to the theory of the administration on the grounds that the amounts deposited in the N.E.I. branch often exceed, in fact, the amounts loaned by the branch, and, therefore, the above-described limitation should not be applied to the interest actually paid by the local branch to its depositors. To such arguments the administration replies that it is impossible to say that income from loans is earned solely by the use of deposits. Amounts deposited become mingled with the capital. Depositors will not put their money in a bank unless it has sufficient capital to assure them of the safe return of their money when wanted. Consequently, it is presumed that earnings should be attributed to capital and deposits in the ratio of their respective amounts. This ratio is the same in all the branches of the business (with the possible exception of banks of issue and banks working in countries with abnormally high or low rates of interest). The ratio between the capital and deposits of the N.E.I. branch is therefore presumed by the authorities to be the same as the proportion between the company’s entire capital and deposits, regardless of the amount of capital allotted to the local branch in the books of the parent bank, and this proportion limits the amount of interest on deposits that may be deducted. Another argument in favour of the views of the administration is that the computing of the so-called East Indian capital by the taxpayers themselves may be exceedingly arbitrary. As certain taxpayers object to these views, they may eventually be tested before the Court of Tax Appeals.

118. Where the head office of a foreign bank lends money to the head office of a foreign company for use in its business or exploitation in N.E.I., the interest on such loan is generally allocated by the authorities to the bank’s branch in N.E.I., even though the bank itself may not do so.

#### (c) INSURANCE ENTERPRISES

119. In general the local branches of foreign insurance companies are taxed on the basis of their separate accounts, subject of course to verification, unless they elect to be taxed by the fractional method described in paragraph 33.

#### (d) TRANSPORT ENTERPRISES

120. The geographical situation of the N.E.I. makes it a matter of course that, by these enterprises, we can only mean those engaged in shipping and air transport. As from January 1st, 1933, non-resident shipping and air-transport enterprises are exempt on profits derived from freight and passenger service between foreign countries and N.E.I., but not from inter-island transportation (see paragraphs 18 and 31).

121. The principle on which the calculation of the profits of foreign shipping companies has been based in the past is that 50 per cent of the profits made by transport by land and water from country A to country B is allowed for each country. Therefore, the formula for the East Indian profits is: $${\rm{N}}{\rm{.E}}{\rm{.I}}{\rm{.}}\;{\rm{net}}\;{\rm{profit}} = {{\mathop {{\rm{Inter - island freight and passage money, plus half}}}\limits_{{\rm{freight and passage money to and from N}}{\rm{.E}}{\rm{.I}}{\rm{.}}} } \over {{\rm{Total amount of freight and passage money}}}} \times {\rm{total net profit}}$$ Notwithstanding the opposition of the principal shipping companies, the Court of Tax Appeals has always upheld this formula, which has been accepted by the foreign companies whose interests in the levies in this country are not so great.

#### (e) POWER, LIGHT AND GAS ENTERPRISES

122. In view of the geographical situation of the N.E.I., these foreign enterprises are of no importance. Foreign companies, exploiting such industries in this country and also abroad, can always arrange their book-keeping in such a manner that the profits made by the industries established in this country can be calculated or computed without any trouble. The only possible difficulties might arise from the distribution of overhead expenses and calculation of interest.

#### (f) TELEGRAPH AND TELEPHONE ENTERPRISES

123. Only the cable companies are of importance here, as practically the whole of the telephone service is exploited by the Government. The N.E.I. net profits of a cable company are calculated by apportioning the total net profit in the ratio of gross receipts.

#### (g) MINING ENTERPRISES

124. As a general rule, mining enterprises in N.E.I. present few difficulties, as their operations do not extend abroad.

Local oil industries give rise to serious problems, however, because they are merely a part of world concerns, and the determination of the sale price is very difficult. Until now, the basis of calculation of the production profits of the concerns producing here and selling abroad has been the so-called “gulf price” of oil. The oil sold in N.E.I. is entirely produced here.