Sweden’s tax authority has taken multiple private equity firms to court, claiming carried interest received by partners should be taxed as ordinary income (which could be taxed as high as 57 percent), and not treated under the more favorable 30 percent capital gains rate. Should private equity firms in Sweden consider changing their tax structure in light of these cases?
Currently several cases are pending at the County Administrative Court, but in December 2012 the court settled one case concerning taxation of an advisory company. In that case, the court ruled in favor of the Tax Agency and considered carried interest as income for the advisory company, and as salary paid to members of the management team responsible for the investments and key executives who had invested separately in the fund.
Please also note the advisory company had not invested any capital in the fund, so legally the company had only a right to a normal management fee. The consequences are that carried interest is considered as taxable income for the company and the company can deduct salary costs, but the carried interest is also included in the company’s basis for social contribution charges (31.42 percent). Also tax surcharges have been imposed on the company. This case is now pending in the Administrative Court of Appeal.
In the above case the advisory company had no right to the return on the investment and the company was fully compensated for its services through the management fee. This means there is no legal or economic ground for considering carried interest to be an income for that company, and normally it is these matters that shall be decisive for the tax treatment.
In our opinion, the possibility to disallow the tax payer to choose legal form from a tax point of view is very limited. It should be noted the Tax Agency in the pending cases applies a look-through principle and ignores negotiated third party agreements, which are fully valid and legal corporate structures and accepted industry practices. So the relevant main issue should instead be whether there is any legal ground in Sweden to tax carried interest as salary. According to our view, there is no such legal ground.
However, it should also be mentioned The National Tax Board recently stated in an advanced ruling that carried interest received by a Swedish limited liability company acting as a general partner shall be considered as ordinary business income and not as tax exempt capital gain. The advanced ruling is appealed by both the applicant and the Tax Agency and the case is now pending in the Supreme Administrative Court.
It is likely some pending cases will be settled in the County Administrative Court this autumn, but it is not likely that battle will end before the Supreme Administrative Court has settled the matter and Sweden has adopted a certain tax regime for private equity firms and their owners and management teams.
Sören Brekell and Niclas Hermansson are tax partners at Sweden-based law firm Setterwalls.