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THE COMMISSION METHOD.1

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48. The commission method is based on the assumption that goods are consigned to the sales branch in the same manner as they would be to an independent commission agent. The essential feature of a consignment as distinguished from trading is the retention of title by the consignor. Goods are placed in the custody of a consignee who has the power to sell them and to transfer title to the purchaser, but until the time of sale ownership is vested in the consignor. The consignee’s remuneration for handling the goods may take the form of a commission on sales, or possibly a profit measured by the excess of the selling price over a price agreed upon by the consignor and the consignee. Since the consignee. Since the consignee commonly receives a commission, this method of transacting business is often referred to as the commission basis. The commission method, however, may be used where an agent makes sales for direct delivery to the customer without handling the goods himself.

49. The case with which branch earnings may be determined constitutes the principal advantage of the commission method. Since, under this method, the earnings of a branch depend upon its turnover rather than upon the margin between the cost and sale price of merchandise, there is no problem of inventory valuation. Likewise there is no need for the local authorities to enquire into foreign costs of production, the investment in foreign plants, or the like. The net profit of a branch may be computed by applying a reasonable rate of commission to sales receipts and deducting branch operating expenses. Branch sales may be readily ascertained and verified. The reasonableness of a rate of commission may be tested by a study of operating statistics and by comparison with independent concerns. Branch expenses, moreover, are likely to consist largely of items locally paid or of supplies furnished by the home office, and such charges as a rule can be verified without great difficulty. A more difficult problem arises, however, in connection with those general overhead expenses which cannot be assigned specifically to any branch of an enterprise. As all the general overhead expenses are very likely to be included in and covered by the selling price of the product itself, it is doubtful if there should be any apportionment of these to a sales branch compensated on the commission basis.

50. Opposition on the part of certain tax administrators to the use of a commission basis for the determination of branch profits is probably due to dissatisfaction with the rates employed rather than with the method itself. Nominal commission rates which really constitute nothing more than a brokerage charge are obviously inadequate and inappropriate for branches engaged in merchandising. Such rates are appropriate for branches which conduct the equivalent of a brokerage business, but merchandising usually involves advertising, the carrying of a stock of goods, the management of sales campaigns and the making of collections as well. Broad functions such as these require that the branch be given a correspondingly large share in the total profit. They require, in fact, that the rate of commission allowed to a branch be comparable to the rate of gross profit normally realised by independent concerns engaged in the same kind of business.

51. Were it not for the delicate problem in connection with the risks incident to ownership, it would be possible to say that the commission allowed to a sales branch should be equal to the margin of gross profit demanded by independent dealers who perform the same functions. It is generally maintained, however, that, in contracts with independent dealers, commission rates are normally lower than margins of gross profit because of the lesser risk incurred by dealers who do not buy goods in advance of sale.

52. If business in the trade is commonly transacted through commission agents, then branch commissions should be at the same level if functions are the same. Any attempt to enforce higher branch rates in ascertaining taxable income would simply force the business into other channels. If in another trade, however, goods are commonly purchased outright, the branch commission would be approximately equivalent to the average gross profit margins, less an amount corresponding to the risks of ownership which are not borne by the branch. The adjustment in respect of such an intangible factor as risk will of course be difficult.

53. In judging the reasonableness of a branch commission rate, the functions of the branch must be given careful consideration. Low commission rates and low profit margins for independent dealers may sometimes be made possible by the fact that the manufacturer carries the burden of advertising the product to ultimate consumers. If this function is handled by a branch and not by independent dealers or commission agents, it is obvious that an allowance for this factor must be made in comparing rates. The problem is complex, but not insoluble, since, in a given trade, branch organisation is likely to run parallel to that of independent units in the same line. An analysis and comparison of results shown by branches and independents should at least provide the basis for a reasonable agreement on commission rates. Once accepted, these rates would not have to be changed often.

54. As the commission is measured by a percentage of turnover, it may happen that the sales branch will show a profit on sales which resulted in a loss to the company, whether the loss is due to a reduction in price or in volume of sales. This situation, however, is not likely to occur, except in the case of dumping1 or an extraordinary fall in prices or in the value of currency in the country of sale. Ordinarily an enterprise will not produce and ship goods for sale in another country unless there are good prospects of realising a profit. Nevertheless, it would seem reasonable to establish a rule to the effect that a corporation should be permitted to reduce branch commission rates if it can show that the proceeds remaining after deducting existing commission rates from sales receipts is less than the production cost of the goods sold. It would seem to be a sound principle that, except in unusual conditions, goods should not be billed directly or indirectly to a sales branch at less than the cost of production.

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55. In the list of allocation methods, the commission basis was placed first, not only because it provides the simplest method for determining the profits of a sales branch, but also because it avoids the difficulties which arise in connection with unrealised profits in branch inventories. Unrealised profits appear whenever inter-branch transfers are treated as sales and billed by the manufacturing division at more than cost. It would seem to be wise to avoid this difficulty in so far as possible, rather than to seek a more or less complicated remedy.

56. The final argument in favour of the commission basis is a very practical one. There is a grave question whether a country can regularly collect an income-tax on branch profits which are in excess of the normal rate of commission or the normal rate of gross profit earned by independent concerns. If an attempt is made to tax a substantial part of the profits which may be attributable to the goodwill of the manufacturing company abroad, taxpayers are likely to seek methods of avoidance by the use of subsidiary companies, nominees, or other devices. The commission basis has the advantage of yielding a higher amount in proportion to increases in prices and volume of sales. It may still be argued that this basis does not give the country in which the sale occurs a sufficient share of very high profits, but the regularity of profits determined by the commission method should compensate for this in the long run. Other methods of allocation will be presented, but none of them compare with the commission method in simplicity and directness of approach.

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