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Fine-tuning in international tax planning – the art of allocating head office’s management expenses to its foreign permanent establishments

The Spanish Supreme Court recently ruled on the criteria to be used to allocate (part of) the general management and administrative expenses of a Spanish head office’s group to its foreign permanent establishments (PE).

The question is a pivotal issue of how to determine the taxable income subject to Spanish corporate income tax (CIT) earned by Spanish tax resident entities, or head offices, through their non-Spanish PE. More so as, subject to certain requirements, profits allocated to the PE will benefit from a full CIT exemption. The court’s interpretation clarifies some grey areas regarding taxation of Spanish companies doing business abroad.


The core issue was the methodology used to calculate the profit resulting from the activities of a Spanish company carried out through its PE in a foreign jurisdiction, particularly concerning the tax exemption for income obtained abroad through a PE (PE Income Exemption) regulated in article 22 of the Spanish Corporate Income Tax Law (CIT Law).

Under the PE Income Exemption, income obtained by a Spanish head office through a PE located outside Spain will be CIT exempt when the PE is subject to and not exempt from a tax of identical or similar nature to Spanish CIT at a nominal rate of at least 10%. The Spanish tax authorities have deemed this requirement to be met when the PE is located in a jurisdiction that has signed a tax treaty with Spain that provides for effective information exchange, as long as the tax treaty is applicable to the PE. 

The allocation of expenses to a PE has a crucial effect on the extent of the PE Income Exemption, as it can increase, or reduce, the profits obtained by a PE (which will be Spanish CIT exempt) and reduce, or increase, the profits of the PE’s head office that are subject to tax in Spain.

Scope of the dispute

In the context of a tax audit, the tax authorities used a proportionality criterion which they applied to the total general management and administrative expenses incurred by the PE’s head office (disregarding their connection, or lack of it, with the PE’s business purpose and activity). This proportion was applied taking into account the net investment made in Algeria (where the PE was located) vs. the total net tangible assets within the consolidated accounts of the PE’s group of control. The tax authorities based their approach, or so they claimed, on Article 7(3) of the OECD Model Convention and its commentaries (according to which it may be appropriate to allocate a proportional part of the expenses based on the relationship between the sales volume of the PE – or even its gross profit – and that of the entire head office company). 

Decision of the Spanish Supreme Court

The Supreme Court considered that the crucial issue before it was whether all general management and administrative expenses should be taken into account when allocating expenses to the PE (which was the position of the Spanish tax authorities) or, as argued for by the taxpayer, only those expenses reasonably linked to the PE’s business purpose. In this way, the Supreme Court highlighted the importance of identifying and categorising said general management and administration expenses prior to allocating them under a proportionality criterion.

The Supreme Court ruled that, when using a proportionality criterion, those general management and administration expenses lacking a reasonable connection with the specific business purpose of the PE must be left out of account. The Supreme Court also considered the role of the OECD Model Convention and associated commentary which the tax authorities relied on to justify adopting a proportionality criterion. The Supreme Court recalled that, although these international guidelines can aid the interpretation of double tax treaties, they are not directly binding and should not be applied in a completely prescriptive manner when it comes to Spanish domestic tax law. 


General management and administrative expenses can be proportionally allocated to the PE, but only if they are expenses reasonably related to the PE’s business purpose. The core issue is how to precisely identify expenses that can “reasonably” be associated with the PE’s business purpose. The Supreme Court emphasised the importance of previously selecting those expenses that are linked to the PE’s business purpose.

However, the Supreme Court’s criterion could act as a double-edged sword, as it enables the Spanish tax authorities to question the tax deductibility of the general and administrative expenses of Spanish PEs of non-Spanish head offices which are not reasonably related to the PE’s business purpose. 


uria menendez, spanish tax, permanent establishment