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(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.

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