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4. Buying Establishments

109. Simultaneously with the swing to the viewpoint that the circumstances of purchasing abroad may contribute to the profit realised on the sale of imported goods in N.E.I., the opinion on the taxation of the foreign export houses also underwent a change. There are several foreign enterprises whose activities in N.E.I. are restricted exclusively to buying raw materials for manufacture or retail sale by the principal establishment abroad. These enterprises were exempted formerly, especially when they went in for wholesale buying — for instance, from the large-scale producers (or their agents) of such products as copra, tea, rubber and sugar. According to the ideas now prevailing, there is no reason for this exemption. In the absence of more accurate information concerning the wholesale buying of raw materials for a world concern, it may be sufficient to treat as East Indian profit an amount equal to the usual commission on the purchases that would be paid to an independent purchasing agent, especially when the buying transactions were effected by a subsidiary company, which is substantially in the position of a commission agent. In such case no assessment would be made on the parent company itself. This method of calculating the East Indian profit for the buying establishment, without taking into consideration the results obtained by the whole concern, may not be entirely satisfactory. But there does not seem to be any immediate prospect of a change in view of the difficulties in getting a true insight into the total profit of the foreign concern and the influence of the various business factors.

110. When the concern specialises in buying the products of small native farmers, very often an extensive buying organisation is required, entailing intricate financial transactions (the “advance system”). In such cases, the buying is such an important factor in the making of profits, and the selling abroad is, as a rule, such a very simple transaction, that more than half is to be put down as East Indian profits. But here, as elsewhere, the peculiarities inherent in a specified enterprise may call for special decisions on the part of the authorities. As an example, the business of buying pepper may be taken. There are a few foreign pepper dealers, who not only buy their pepper in the local market in Batavia, but also have their local buying agents in different places in South Sumatra, and, by giving advances to local growers or smaller buying agents, ensure themselves of the quantity of pepper needed for their trade. Such a buying organisation involves considerable risk and expenditure, requires a knowledge of the country, the people and the local markets, and is obviously a much more important factor in the enterprise than the office in London or New York, which sells the pepper on the produce exchange.

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.

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