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Appendix II. APPORTIONMENT OF PROFITS OR CAPITAL FROM ENTERPRISES OPERATING IN SEVERAL COUNTRIES.

Summary by Professor Adams of the Replies received to the Questionnaire.

The replies to the questionnaire reveal great diversity of law and practice regarding most of the subjects to which the questions are addressed. Moreover, many of the replies are incomplete. In the case of such questions, it is difficult to make a satisfactory summary, and it is plain in general that an accurate comparison of law and practice can only be made by a group of experts who will devote their entire time to this subject for a period of a year or more. The principal significance of the questionnaire is the proof which it supplies of the need for systematic and continuous study.

Nevertheless, on one or two points of importance, the replies reveal a close approach to uniformity of law and practice. It appears clear, for instance, that, in assessing the profits of a branch of a foreign company (and more particularly in assessing the profits of a subsidiary or [?] of a foreign holding company), a large majority of States avowedly seek to determine the profits of the branch separately and for that purpose pay regard only to the accounts of the branch itself, without reference to the accounts of the foreign company. In the absence of separate


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accounts, or where the separate accounting is unsatisfactory, various methods of approximation are widely used. But only in a small minority of States is preference given to the “method of apportionment” by which the income of the branch or subsidiary is computed as a fraction of the entire income of the foreign corporation or holding company.

The following summary is neither accurate nor complete. But, under some questions, it reveals uniformities which are real and significant and, under others, diversities of law and practice which are highly important.

Question (a):

By what general methods does the administration of your country arrive at the ascertainment of the profits of undertakings operating in several countries?

A. Undertakings domicilednote in one State with Branches in Foreign Countries.

Practically all States call for a full declaration of profits in such cases, and a large majority of States hold the entire income subject to taxation in some manner or degree. Nevertheless, the most significant aspect of the replies is their evidence of the growing extent to which some amelioration or reduction is granted in respect of profits earned abroad.

1. A number of States practically exempt profits allocated to establishments located in foreign countries (hereafter called “foreign establishments”) — Bolivia, Danzig, Estonia, France, Hungary, Italy (for certain classes of undertakings), Japan (business-profits tax), Netherlands (as regards unincorporated undertakings), Spain (as regards the trade-licence tax), the United States of America (by deduction against its tax).

2. An important group of States, by deduction or reduction of rate, exempt the greater part of the profits allocated to foreign establishments, reserving a minimum part for the home country — Austria, Belgium, Greece (limited companies only), Netherlands (tax on distributed profits of corporations), Spain, Switzerland.

3. Canada, Germany, Great Britain, Greece (unincorporated undertakings), Japan (for income tax), Roumania, Poland, South Africa and Sweden, tax the entire profits as a general rule, but important deductions or offsets for profits taxed in certain other jurisdictions are given in Great Britain (Dominion taxes only), Canada and probably other States here mentioned.

4. The practice of exempting profits allocated to establishments located in countries with which the home country has a bilateral convention for the prevention of double taxation is apparently spreading.

B. Local Branches of Foreign Undertakings.

This case is considered under question (b).

Question (a) bis:

By what general methods does the Administration of your country arrive at the ascertainment of the profits of trust and holding companies operating in several countries?

A. Where a Holding Company domiciled in one State controls one or more Foreign Subsidiary Companies.note

The replies indicate that, in a majority of the countries, no distinctive status is given to the holding company for purposes of taxation, and the dependent or affiliated corporation is taxed as an autonomous corporation. In such States, if the dividends received by an ordinary corporation are taxable (e.g., Japan), the dividends received by a holding company are taxable: if dividends are exempt to an ordinary corporation, they are exempt to the holding company (e.g., South Africa and the United States of America). In Austria, the Netherlands and Spain, a partial exemption is granted. A foreign subsidiary of a German holding company is taxed with the parent company if the two constitute an economic unit.

B. Where a Subsidiary Corporation is controlled by a Foreign Holding Company.

This case is considered under question (c).




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Question (b):

What are the methods for determining the income of branches of foreign business concerns doing business in your country?

The method followed by most countries in the first instance is to base the assessment on the separate accounts of the branch which is taxable only on income derived within the taxing State. Belgium and Poland specifically require special accounts for the branch, and it is the practice in other countries for branches to keep separate accounts. If the special accounts of the branch establishment are inadequate or misleading, they may be corrected to reflect the true income, or various empirical methods may be employed to estimate the taxable profit.

The principal methods employed are the following:

  • (a) The accounts of the entire undertaking are demanded in order to determine the amount of profit allocable to the branch. This amount may be determined by an apportionment taking into account the assets, turnover, expenditure or number of employees of the branch as compared with the assets, turnover, expenditure, or number of employees of the entire undertaking.
  • (b) The income of the branch may be determined by basing the assessment on a comparison with the earnings of local undertakings engaged in similar business, for example, by ascertaining the percentage of net profit to gross turnover of such undertakings (Belgium, France, Great Britain, etc.). The law of one country (Germany) provides that, when such method is employed, the assessment cannot be less than a minimum equal to the normal rate of interest on the capital invested in the local branch.
  • (c) The income of the local establishment is estimated by reference to a certain extent on external indications, such as salaries of employees, rent paid for premises and other expenditure.
  • (d) The income may be assessed in a lump sum which serves as the basis for taxation for several years (Germany).

A very few countries base the tax in the first instance on a certain proportion of the total income of the foreign undertaking (Spain and a few Swiss cantons). Another country may assess the profits of the branch in that manner when it has no regular separate accounting and certain other prescribed methods are not applied (Germany). The law of another country provides for an apportionment corresponding to the ratio of assets, but ordinarily employs the separate accounting method, condemning the method of proportional allocation on the ground that there is no necessary relation between the local situation of a capital asset and the income earned in the area in which it is situated, and that it is unsatisfactory in practice and productive of anomalies (South Africa).

Question (c):

Ditto for affiliated corporations.

Practically all the replies state categorically that the local company, which is a subsidiary of a foreign corporation, is a separate legal entity and enjoys the same treatment as other national companies. It is therefore taxed on the basis of its own accounts. A number of replies mention measures that may be taken to assess the profits of a subsidiary company correctly when its accounts are inadequate or misleading, and notably the following:

  • (a) A profit may be ascribed to the subsidiary company based on a comparison with the profits of other companies engaged in a similar business. In making such comparison, the law of one country (Belgium) authorises taking into account the capital invested, turnover, number of workers, rental of real estate, motor power employed and other relevant data.
  • (b) Where the subsidiary is rendering services to the foreign parent, its profit may be fixed on a commission basis.
  • (c) When the subsidiary and the foreign parent constitute a “single economic unit”, the subsidiary may be treated as a branch (Germany, Spain).
  • (d) In order to prevent evasion or show true income, the fiscal authorities may allocate income as between the foreign parent company and the local subsidiary (United States of America).
  • (e) Where the profits of a subsidiary are artificially concealed, a charge may be made upon the parent company based upon the true profits of the subsidiary (Great Britain and Spain).

The question of allocation as between a foreign parent and a subsidiary corporation organised in the Netherlands or in Greece is evidently of secondary importance, as such corporations are not taxed until profits are distributed.




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Question (d):

(d) In the case of (1) branches and (2) affiliated corporations:

  • (i) Is the income of the branch or affiliated [?] corporation determined separately? or
  • (ii) Is it determined as a fraction of the entire income of the company of which the taxpayer is a branch or to which it is affiliated? or
  • (iii) Has the Administration the option of following either method?

Answered under questions (a) and (b).

Question (e):

If the method (ii) is followed, what system is employed for checking the income of the mother-company?

In practically no reply is any regular system described for checking the income of the mother-company. The balance-sheet and profit-and-loss account and other pertinent information may be requested from the parent company and carefully examined, but the difficulties of checking such information are admitted.

Questions (f) and (g):

  • (f) When the branch or affiliated corporation in your country operates at a profit, whereas the entire concern operates at a loss, is any cognisance taken of the loss in determining the income of the branch or affiliated corporation?
  • (g) What is your practice if the branch or affiliated corporation in your country operates at a loss, whereas the entire enterprise realises a profit?

Practically all the countries which base the assessment of the branch on separate accounting answer categorically that no attention is paid to the profit or loss of the parent company in determining the liability of the branch. The branch is taxed in accordance with the showing of its own accounts, provided they are properly kept. One country (Spain) allocates to the branch a proportion of the profit or loss of the entire concern, because it treats the branch and the entire concern as a unit. Similarly, the Swiss cantons which tax on the proportional allocation basis, and the few other countries which exceptionally tax on that basis, declare that they take into account the profit or loss of the entire concern.

Subsidiary companies are, according to the replies, always taxed independently of the foreign parent, except that Spain merges the subsidiary with the foreign parent for purposes of ascertaining tax liability, and the German law authorises the taxation of the subsidiary with the foreign parent when they form a single economic unit.

Question (h):

When a company has its real centre of management in your country, but its other operations (for example, manufacture) in another country, is a fraction of the profits ascribed to the head office and, if so, how is that fraction determined?

Summarily stated:

  • 1. The largest number of responding States tax the entire profits in such a case — Bulgaria, Canada, Great Britain, Greece (except for limited companies), Germany, Japan (income tax), Poland, Roumania, South Africa (when sales are controlled in South Africa).
  • 2. A smaller number attach minor importance to the real centre of management, and allocate profits primarily to the countries or establishments of manufacture and sale — Estonia, Danzig, France, Hungary, Japan (business profits tax), United States of America.
  • 3. Other countries, in effect, ascribe a fraction of the profits to the head office: Austria (not less than one-tenth for limited companies and one-quarter for commercial partnerships or private companies), Belgium (rate reduced to one-quarter on profits realised and taxed abroad), Bolivia (less taxes paid abroad), Italy (when Article 9 of the Royal Decree of August 12th, 1927, is not applicable), Netherlands (taxable distributed profits accruing outside reduced by two-thirds),


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    Spain (Spanish companies taxable in respect of not less than one-third of the profits), Switzerland (a minimum profit varying from 10 to 25 per cent).

Question (i):

When a company has its real centre of management in some other country than yours, but other operations (for example, manufacture), in your country, is a tax imposed in your country and, if so, how is it assessed?

Practically all the answers to this question are in the affirmative, but in South Africa, “if an intermediary stage in a series of business transactions which resulted, as a whole, in the production of income were carried out in the Union, no attempt would be made to assess for Union taxation a portion of the profit derived from transactions which, as a whole, were controlled from outside the Union”.

The method of assessment is usually not stated in detail, but in a majority of States profits are determined on the basis of a separate accounting or balance-sheet, where available. Only two replies (from Spain and Switzerland) state that a fraction or portion of the profits may be ascribed to the centre of management situated in another country. In the Netherlands, “when the company has its real centre of management in a country other than the Netherlands, but its other operations are carried on in the Netherlands, the total profits are deemed to be realised in the Netherlands”.

In Italy, the tax is assessed “on the industrial income—that is, on a part of the profits representing the difference between the cost of production and the sale price of wholesale merchants in the country”.

Question (j):

If a company, with its head office in one State, has a branch in your State which makes sales in a third State without having there a permanent establishment, are the profits derived from the sales in the third State ascribed to the branch or to the head office or partly to each?

In a large majority of the States, such profits are ascribed to the branch. For Great Britain, the answer depends upon whether the trade in the third State is controlled by the branch. In Spain such profits “are always ascribed to the head office”. In Sweden, such profits would be exempt from Swedish taxes if manufacture did not take place in Sweden.

Question (k):

With regard to any of the above cases, is any special method of assessment followed where there are permanent establishments in your country belonging to the following foreign enterprises, and, if so, what method?

  • (a) Banks and banking companies;
  • (b) Insurance companies;
  • (c) Railroad, motor-omnibus and other transport companies;
  • (d) Power and light companies;
  • (e) Gas companies;
  • (f) Telegraph and telephone companies;
  • (g) Mining and extractive industries;
  • (h) All other kinds of firms for which special methods would be necessary.

Most of the countries consulted apply the general rules contained in their law to the enterprises mentioned under (k) with the possible exception of insurance companies. The special methods indicated by them for determining the income of these enterprises are only in many cases methods of checking or supplementing the ordinary accounts of the branch, which as a general rule continue to be the basis of assessment.

In Bolivia, a 40 per cent deduction is made on gross profits in respect of expenses; the remaining 60 per cent are regarded as net profits and are taxed.

(a) Banks. — The taxable profits, in relation to the total profits, of a bank in a country where the bank possesses agencies is determined by the ratio of expenditure on staff in that country to the total expenditure on staff (agreements made by Austria with Hungary and Czechoslovakia, Free City of Danzig).


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In other countries—more particularly for the purpose of checking the accounts—the ratio is taken of the gross receipts obtained in the country to the total gross receipts (Germany, Danzig), or the ratio of local transactions to total transactions (Italy, Spain).

In the Netherlands, the Administration has issued detailed rules for the calculation of the profits realised by a branch bank. These rules are to some extent associated with those relating to the apportionment of working capital.

(b) Insurance companies. — The methods of assessment most generally adopted for the purpose of determining the share of the total profit falling to a specific country consists in taking the proportion of the premiums collected in that country to the total premiums collected by the company (Austria in the treaties of that country with Hungary and Czechoslovakia, Danzig, Finland, Germany, Italy, South Africa, Spain, Switzerland).

Certain countries calculate the profits as a lump sum and apply for this purpose a coefficient to the amount of the premiums collected; thus, in the Netherlands, profits are as a general rate estimated at 10 per cent of the premiums collected in that country (companies may, however, if they so request, be assessed as laid down in the previous paragraph). In Sweden, the taxable income is also a percentage of the gross premiums collected: 5 per cent for marine insurance, 6 per cent for fire, 15 per cent for life insurance, 10 per cent for other branches of insurance.

Other countries fix profits, not in proportion to the total profits of the company, but by comparison with national undertakings: the percentage of profits in relation to the amount of the premiums collected in the country must be the same. This is the principle applied in France (the method is, as a matter of fact, optional) and in Portugal.

(c) Railroad and other transport companies. — The profits earned in a country may be assessed in relation to the total profits of the company, either by taking the mileage in the country (Danzig, Switzerland), or by reference to the comparative amount of the revenue obtained (Spain, Italy), or, on the other hand, to the expenditure incurred in the country (United States of America).

In Bolivia, 45 per cent of gross profits are regarded as expenses, and 55 per cent are taxed.

The Netherlands fix the taxable income of railways by applying a coefficient of the amounts collected in the Netherlands. In South Africa, the taxable profits of shipping companies is fixed at 10 per cent on freight for passengers, live-stock, mails and goods shipped in the Union.

(f) Telegraph and telephone companies. — South Africa determines the income of submarine telegraph and wireless telegraph companies by taking 5 per cent of the amount payable in respect of all messages delivered for transmission from any office within the Union.

Question (l):

Are any special methods of assessment employed in the following cases:

  • 1. Enterprises manufacturing or buying in another country and selling through a permanent establishment in your country: what is your method of determining the profit of the latter establishment?

Apparently, all countries with an income tax impose it on profits derived from selling through a permanent establishment in their territory goods that have been manufactured or bought in another country. The basis of assessment in most cases is evidently the net sales of “merchanting” profit realised within the country, allowing, in the case of goods manufactured in another country, a manufacturing profit to the latter. In some instances, however, where goods are purchased in one country and sold in another, the entire profit is taxable in the country of sale (Great Britain, United States of America).

South Africa usually accepts the Customs evaluation as the basis for determining the sales profit.

The Swiss cantons in most instances tax the excess realised over current market prices, or base the assessment on the profit realised by an independent Swiss firm.

Greece allows a deduction from the net sales profit equal to 5 per cent for general expenditure of the head office.

Austria has adopted arbitrary allocation fractions, being half-and-half where an undertaking buys in one State and sells in Austria or vice versa, and two-thirds of the profit for the State of manufacture and one-third for the State of sale.

  • 2. Enterprises manufacturing in your country and selling elsewhere: is a profit ascribed to the manufacturing establishment?

The general rule seems to be that a certain profit should be ascribed to manufacturing in a given State, although the goods are exported and sold elsewhere. South African law goes farther and


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Declares the whole of the profits taxable if the control of the enterprise is in its territory. Austria allocates two-thirds to the country of the manufacture and one-third to the country of sale.

  • 3. Enterprises continuously buying is your country through a permanent establishment but selling in another country: is any profit ascribed to the buying establishment?
  • 4. Enterprises purchasing raw materials from other companies in your country with a view to manufacturing and selling elsewhere: is the foreign enterprise deemed to be carrying on business in your country and taxable on a presumed profit?

The great majority of States declare categorically that they do not endeavour to allocate a profit to buying establishments situated in their territory and do not try to tax a foreign concern which buys raw materials directly from local enterprises. A few States, however, assimilate the buying establishment to an export house (Bulgaria, Portugal) or assess the buying establishment on the basis of a commission (e.g., the Netherlands, Spain). France and Germany hold such a foreign company taxable on profits derived through a permanent establishment for the purposes of the tax on industrial and commercial profits.

Austria also allots a fraction of the profit to a buying office and, where there is no buying office, it allots a fraction of the profits for tax purposes if the materials purchased are exported through the commercial travellers employed by the head of the undertaking, or the latter himself.

Question (m):

When a company has a debenture debt, is the charge on this debt ascribed solely to the real centre of management or is it distributed between the different permanent establishments? In the latter case, what is the system of distribution?

Practically all countries recognise the rule of apportioning the interest charge on a debenture debt of the company to the various branches or sources as a part of the overhead or debt in the proportion that they are concerned, or in proportion to capital employed (Italy, Sweden), to assets (Japan), to profits (Spain), or to income, receipts or some other factors (Germany), or to gross income (United States of America).

Belgium regards such charges as attaching exclusively to the foreign central office responsible for the issue, unless a part of the loan has been especially allocated for the requirements of the Belgian establishments. Where the head office is abroad, Portugal takes no account of debts. As Great Britain does not allow interest to be deducted in determining assessable profits, no question of apportionment arises.

Questions (o) and (p):

  • (o) What are in this connection the chief difficulties of an international character which the administration in your country has experienced?
  • (p) Are there any particular suggestions or recommendations which you would like to communicate to the Fiscal Committee in this connection?

A considerable number of States, while not alleging that the international difficulties which they have experienced in connection with the taxation of undertakings operating in several countries are important, nevertheless mention the practical difficulties they have encountered and suggest the lines on which they think a solution might be found.

One of the questions most often referred to is the difficulty of exactly determining the profits on manufacture and the profits on sale. Denmark suggests meeting this difficulty either by applying a general coefficient to the business turnover or, preferably, by imposing taxation only in the country in which the business operations yielding the profits were carried on (the effect of this would be to eliminate the country in which the head office is situated in all cases when neither the manufacture nor sale took place in that country, but the problems would still remain when manufacture and sale took place in different countries).

As regards balance-sheets separately drawn up by each establishment, Austria and Hungary indicate practical difficulties which may arise in this way (when, for example, one of the countries concerned objects to the balance-sheet in so far as it is concerned and desires to include profits which have already been taxed in another country), and they suggest that international agreements should lay down detailed and uniform rules for the allocation of taxation. For example, Austria proposes conventional percentages of allocation. Other countries, such as the United States of


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America, consider the method of “separate accounting” as decidedly preferable to any hard-and-fast formula for allocation.

Canada desires that the principle of reciprocity should be established in regard to exemption: the United States of America, on much the same lines, recommends that the country of the head office should grant a credit or offset for taxes already paid in foreign countries.

Switzerland asks that the Fiscal Committee should not adopt too wide a definition of the term “permanent establishment”. This would limit the number of cases to which the rules regarding the allocation of profits would apply and would improve political and commercial relations between the countries.

Finally, Canada recommends the translation of foreign legislation on the taxation of the profits of industrial and commercial undertakings.

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