1. The general problem of reducing or eliminating the double taxation of income falls into two main divisions or categories which are closely related but nevertheless distinct. In one category are the problems arising from the conflict of laws of different tax jurisdictions which seek to tax the same item of income. Such problems are essentially legal in nature and must presumably be solved by means of suitable legislation or treaties. In the other category are the problems of allocation accounting — that is to say, the problems which arise in allocating or assigning business income or profit to different jurisdictions on the basis of general rules or principles prescribed by laws or treaties. This study is concerned only with problems of the latter type, except that certain general rules or principles must be assumed in order to provide a basis for accounting allocations. In accordance with the usual practice throughout the world, it has been assumed that business income or profit is to be taxed in the country of origin at the time of origin rather than at the domicile of the recipient at the time of distribution. Before a satisfactory solution to the problems of allocation accounting can even be expected, it is essential that the nations seeking to eliminate double taxation should decide in principle whether each country in which establishments of an international enterprise are located is to tax:

The one involves general apportionment; the other, separate accounting. Although these two concepts are fundamentally different, they are often used indiscriminately. Unless one or the other is definitely adopted by international agreement, it is inevitable that enterprises which show a profit on their total business but which suffer losses in particular countries will be doubly taxed. The countries in which losses are sustained sometimes seek to levy a tax on a share of the net income of the whole enterprise, while the countries in which the profitable establishments are located naturally levy a tax on the profit originating therein without deduction of losses incurred elsewhere.

2. If the general rule that each country shall tax a portion of the total net income of international enterprises having establishments within its borders be adopted, the method of general apportionment is appropriate. The direct allocation of items of non-operating income such as interest, rents, profit on the sale of real estate, etc., is not inconsistent with the idea of general apportionment as here expressed. The method of general apportionment if intelligently applied may effect a reasonable division of taxable income among different tax jurisdictions, but it will not ordinarily allocate profit to the place of origin. This fact should be obvious, since no general apportionment fraction can in any one year allocate losses to some branches and profits to other branches of the same enterprise. Therefore, in enterprises which have some profitable and some unprofitable branches, this method will always understate the profits of the former and overstate the profits of the latter. The discrepancy between the unquestioned profits of the more profitable branches and the income assigned to them by an apportionment fraction may be so great as to invite suspicion and litigation and, in the end, double taxation.

3. If the general rule that each country shall tax all the net income earned by establishments within its borders, regardless of the total profits or losses of the enterprises concerned, be adopted, however, the method of separate accounting is implied. The aim of separate accounting is to determine for each establishment or group of establishments of an enterprise within a given country the net profit which it would have earned if it had operated as an independent concern under similar conditions. Some branches and subsidiaries are so nearly autonomous and independent in their dealings both with outside concerns and with other units of the same enterprise that a clear determination of the separate profit of each establishment may be readily made. At the other extreme are branches and subsidiaries which are so intimately associated in the operations of a whole enterprise that the allocation of profit to branches must depend largely on the apportionment of operating income and expense accounts. Although separate accounting almost always involves the apportionment of certain items of income and expense, such apportionment differs both in degree and in kind from general apportionment. In separate accounting, items of income and expenses are directly allocated as far as possible to their respective sources, thereby reducing the zone of uncertainty which is inevitable in all apportionments. The remaining items of income and expense which cannot be directly allocated are then apportioned between the establishments concerned with a view to attributing to each the income it would earn if it were an independent enterprise, but not in accordance with the relative importance of different establishments. These apportionments, it should be noted, do not depend in any way on the amount of net profit or loss shown by the group of branches concerned or by the whole enterprise. Branch profit or loss determined by means of separate accounting even though the computation may have involved the apportionment of a number of items is likely to be more truly representative than any general apportionment which divides the total net income of an entire enterprise among its branches at a single operation.

4. It is recommended that separate accounting be approved in principle. This method is regarded as superior to the method of general apportionment for the following reasons among others:


5. Each branch or group of branches within a single tax jurisdiction should be organised as a separate accounting unit with an adequate set of accounts and records. The question of adequacy must be answered in each particular case by considering the completeness and reliability of the information furnished by the branch books and supplementary schedules combined. For tax purposes, it is convenient, but not absolutely necessary, for each branch to have a complete set of accounts and records. A business enterprise should not be compelled to decentralise its accounting and to maintain complete staffs at all branches merely to meet income-tax requirements, provided the enterprise can and does render satisfactory returns based on its centralised accounts.

6. The accounting system of a branch should meet the special legal and tax requirements of the country in which it is located. In particular, it should provide for the segregation of items of income and expense which are directly allocable under fiscal laws and treaties from items of income and expense relating to joint operations in two or more countries.

7. The accounts of each branch should contain a complete analytical record of all inter-branch and inter-company transactions.

8. All transactions (a) between a branch and independent concerns and (b) between a branch and other branches or subsidiaries of the same enterprise should be supported by suitable vouchers or other documents.

9. Foreign Exchange. — Exchange losses and gains may be determined and allocated to the establishments of an enterprise in different countries by either of two general methods. These methods involve either:

The former method is more commonly used, but the latter is suitable for autonomous branches operating on a capitalised basis.


10. The objectives of separate accounting are:

No one method will accomplish all of these objectives in all cases. It is essential that the methods of separate accounting retain their present flexibility in order that they may be applied to all types and conditions of business. International business is so complex and branch relationships are so varied that every tool of accounting and statistics must be kept available without restriction for use in making allocations of profit. The adoption of any manual of uniform procedure which would standardise practice at the present level of development would be most unfortunate.

II. The three general methods of separate accounting which are available are based on:


12. The commission or fee basis for remunerating branch establishments rests on the assumption that business enterprises ordinarily consist of a relatively large and important establishment, usually the real centre of management, and a number of outlying branches and subsidiaries. This central establishment or real centre of management is finally responsible for all profits earned by the enterprise and it may therefore be logically considered as a residual claimant for all profit in excess of the amount necessary to pay outlying branches for services rendered and to justify the investment of capital in them. The commission or fee should be such an amount as would induce an independent person to undertake the business with the expectation that a normal or reasonable volume of business will yield a return on the branch capital commensurate with the degree of risk inherent in the business.

The commission or fee basis is appropriate for buying, certain kinds of processing, and selling establishments. A reasonable commission or fee may be determined by considering the rates charged by independent concerns for similar services, by analysing branch operating accounts, or by both. When commission rates for sales branches are fixed by comparison with rates charged or gross profits earned by other concerns, an enterprise should be allowed to reduce the rate when it can show that the net proceeds remaining after deducting the commission are less than the normal or average cost of production or when branch profits based on the commission are unreasonably high. Manifestly, the commission or fee need not be large enough to provide a profit for the branch during a period when business is less than expected either because of business depression or because a new market is being developed.

The commission basis is the simplest of all methods. It automatically eliminates the problem of unrealised profit in branch inventories. It provides a more regular branch income less subject to extreme fluctuations than the income of branches which “buy” the product. In doing this, it assigns income to a branch proportionate to the volume of business done rather than in accordance with the fluctuation in prices of the commodities. When prices are falling, the income of the branch may not decrease proportionately so long as the volume of business continues: also, when prices are rising, the income of the branch would not necessarily increase unless there were an increase in volume of business.


13. When branch accounts are kept on the so-called independent factory price basis, each branch is treated as a separate business and accounting unit, preferably with a formal capital assigned to it by action of the board of directors. Dealings between autonomous branches of this type are kept on a commercial basis by the use of regular market or dealer prices in all inter-branch billing. Quoted market prices are available for a number of raw or semi-finished commodities, but not usually for manufactured goods which are patented or branded. The prices charged to sales branches handling such articles may be the same as prices charged to independent dealers. Factory prices fixed in this manner will be satisfactory if a substantial portion of the total business is transacted through dealers who are charged a uniform price and who operate on the same scale as the branches. If uniform prices are not used or if operating conditions of branches and dealers differ widely, dealer prices do not furnish a very reliable guide for the determination of inter-branch prices. Reasonable inter-branch prices, however, may often be fixed by a consideration of the margin of gross profit available to sales branches even though there is no fixed dealer price. The use of independently determined prices for inter-branch billing is an excellent method for eliminating bias in the accounts wherever independent criteria for judging the reasonableness of a price are obtainable.

14. The problem of unrealised profit in branch inventories appears whenever goods are billed from one branch to another at a price in excess of cost. If branches were treated exactly as independent concerns this unrealised profit would not be eliminated. The fiction of branch independence, however, cannot be fully maintained and an attempt to do so would lead to arbitrary and unreasonable results. It is therefore recommended that international enterprises be allowed to eliminate unrealised profits in branch inventories from the profit shown by the books of the branch from which the goods in question were shipped.

15. It is proper that each branch of a business enterprise should be charged at a reasonable rate for supplies furnished, services rendered, or expenses incurred in its behalf by the home office or any other branch. Such charges should be the result of specific services rendered and should be subject to reasonably accurate measurement. The apportionment of general overhead expenses to sales branches, however, cannot ordinarily be justified, since an allowance for such charges must be presumed to have been included in the independent factory prices charged for goods. General overhead expenses in a reasonable amount may be apportioned to purchasing, producing, or processing establishments if expenses of this character are not included in the prices or rates charged to such establishments by other establishments.


16. Some enterprises have already introduced, and in the future others will no doubt introduce, accounting and statistical methods by which the profits of different branches may be ascertained with a considerable degree of accuracy. Since such methods require a careful and complete analysis of production and distribution costs and other factors, they can be effectively used only by enterprises which have well-developed cost systems. They cannot be required of all taxpayers, but tax authorities should encourage the development and introduction of better accounting methods by recognising and accepting accounts which do effect a reasonable allocation of income. In default of independently determined prices, the allocation of income may be accomplished by constructing an inter-branch billing price at cost plus a fixed and limited profit or by keeping accounts on a cost basis throughout and apportioning joint profits on different lots or lines of product. Some methods by which this may be done are mentioned in the body of this report, but they must be regarded as suggestions and not as exact standards to be officially adopted in detail. The methods of internal analysis may approach a scientific treatment of the problem of allocating income, but they require the use of data relating to operations in more than one country and therefore raise the problem of verification.


The method of apportioning joint profit on goods manufactured in one country and sold in another in the ratio of conversion cost to distribution cost should be useful both as a check on reported profit and as a means of making allocations. Naturally, it cannot be maintained that joint profit should always be divided in this ratio, but at least it provides a much more reasonable basis than the more common method of making apportionments according to total cost, including the cost of material.


The problem of allocation has thus far been studied chiefly from the point of view of a single sales branch dealing with a single manufacturing establishment of the same enterprise. Other types of branches must now be considered.

17. Manufacturing Establishments. — A manufacturing establishment which transfers merchandise to number of sales branches may charge a uniform price to each or it may use different prices which are adjusted to meet special conditions found at the several branches. The use of a uniform price is convenient, but not always in accord with commercial practice as reflected in transactions between independent concerns. Although some variation in the prices charged to sales branches located in different countries and operating under different conditions seems inevitable, it is recommended that such variations (except in respect to damaged, obsolete or inferior goods) should be strictly limited. It is therefore recommended that, except in unusual conditions, the minimum inter-branch billing price be the normal cost of production defined as the cost of material and labour plus a reasonable share of factory overhead, and that the maximum inter-branch billing price be the price which an independent concern would pay for the same goods under similar conditions — that is, the price which would leave a reasonable margin of gross profit for the sales branch. The income-tax is a poor weapon to use against dumping.

18. Buying Establishments. — Since profits are not ascribed to the purchasing function in ordinary commercial accounting, it is recommended in general that no attempt be made to do so in computing taxable income. Buying expenses according to this theory should follow the merchandise and be charged against the branches or divisions of an enterprise for which purchases are made. If a buying establishment performs additional functions, such as sorting, grading, storing or preliminary processing, it may be desirable to allocate profit to the establishment. This allocation may be made by placing the establishment:

Of the two methods, the former is preferable for general use. There are undoubtedly some circumstances under which the latter method would be appropriate, but placing a branch on a trading basis, unless it is practically autonomous and does trade on its own account, is likely to cause difficulty in connection with hedging operations, if any, or to cause a serious distortion of the profits of both the buying establishment and the other units of the enterprise with which it deals.

19. Processing Establishments and Assembly Plants. — These two types of plants are distinguished from manufacturing establishments by the fact that they perform only a relatively small part in the processes of production. Profit can ordinarily be allocated to intermediate processing establishments by assigning to them as a fee for services rendered an amount sufficient to provide a reasonable return on the investment under normal operating conditions. The problem of allocating profit to assembly plants requires further study in relation to the particular industries involved. The methods suggested in this report for manufacturing establishments will apply to both processing establishments and assembly plants, but special difficulties arise where the final product is the result of a long series of processes in different plants.


20. If a general rule that interest is to be taxed in the country of origin be adopted, it is recommended that no deduction for intra-company interest charged to branches be allowed. Since both interest and profit would be taxable in the same country, there would seem to be little need for distinguishing between them. If interest, however, is to be taxed at the domicile of the recipient, a clear demarcation between business profit and interest must be effected. This may be done by allowing a charge for interest on advances to branches which are operated on a capitalised basis, or by making an apportionment of interest on general indebtedness, but not by both.


21. Branch establishments keeping separate accounts should report their income on regular tax returns supported, if requested, by supplementary schedules summarising and explaining all intra-company transactions.

22. Taxpayers should have the privilege of submitting certified statements of professional accountants supporting the figures shown in the accounts of foreign establishments not subject to review by the local tax authorities. Such statements, if prepared by a reputable firm of accountants, should be given considerable weight in making findings of fact.