Sweden gets tough with private equity

The Swedish government will close a tax loophole that allows private equity firms and others to avoid tax, in what could be a sign of things to come for the industry as it consults with the government over carried interest tax treatment.

The move will increase tax revenue by 6.3 billion Swedish krona ($936 million), the Ministry of Finance said, though this could be counteracted by a reduction in the corporate tax rate.

Firms will no longer be able to avoid tax by borrowing from related firms in jurisdictions with lower tax rates, said Finance Minister Anders Borg in a statement.

“We cannot accept the aggressive and questionable tax arrangements we have seen from, among others, risk capital firms operating in the welfare sector,” he said. “We will not let firms escape their social responsibility.”

There has been outrage in Sweden over firms avoiding taxes on profits from companies in areas like healthcare, elderly care and education that receive a significant portion of their revenue from taxpayers.

By having portfolio businesses borrow money from a holding company in countries like Luxembourg, a company can offset interest payments against tax in Sweden while the holding company pays a much lower rate on the interest-received income.

Under the new rules, a company would only be able to offset repayments if it is ultimately paying a 10 percent tax rate or higher. However, this must be done on commercial grounds, and will not be allowed if solely for tax reasons.

“We are a little concerned that the tax authority could be given the right to prevent deductions if it believes they are not on commercial grounds. That would create uncertainty for businesses as they would be dependent on the tax authority’s view,” says Jonas Rodny of the Swedish Venture Capital Association.

“From a return perspective it’s not a big issue, it has only a 1 or 2 percent effect on returns,” he adds.

While not having a huge effect on buyout activity, the move could portend bigger changes in the future in a country where a third of foreign direct investment comes from private equity.

The government has shown an increasing interest in the industry over the last few years, and investigations into some of Sweden’s leading firms have led to large penalties for both Nordic Capital and IK Investment Partners, although both are appealing the verdict.

Through the SVCA the industry has been trying to reach a compromise deal with the authorities over the treatment of carried interest, accepting that it should be taxed at a higher rate but that carry should not be considered ordinary income.

The SVCA has offered a proposal whereby the first part of any carried interest received would be taxed as ordinary income, and then, over a certain level, as capital gains.

The recent announcement on tax deductions was made independent of that process. “This is the first initiative, there is a committee looking at a long-term solution,” Rodny said.

The committee will not review the proposal officially until this month or next, but the Swedish government has signalled its belief that private equity firms have a social responsibility, and that will doubtless be a major consideration in its verdict on the carried interest question.