Legal Update: Administrative Court of Appeal Rulings on Taxation of Carried Interest
On April 27, the Administrative Court of Appeal (“ACA”) ruled in 85 cases regarding the taxation of carried interest received by partners in private equity funds. The decisions would result in extra tax revenues amounting to approximately SEK 1.6 billion if they gain legal force (and there are many more cases to be decided).
In broad strokes, the issue for the court to decide on was whether carried interest paid from a General Partnership (“GP”) should be taxed in accordance with the “closely-held company” rules. The closely held company rules aim to prevent income conversion in cases where the value is created by a direct or indirect individual shareholder by bifurcating capital income received into salary income (taxed at up to 58%) and capital income (taxed between 20- 30%) based on a formula. All the rulings were generally in favour of the Swedish Tax Agency (“STA”) although the outcome in the cases differed slightly. Further, the STA also managed to get the court to share their view that interest from Participating Loan Agreements should be taxed as income from employment (this will not be discussed in detail in this update).
The ACA held that, in accordance with what can be described as nothing other than a substance-over-form approach, the relevant partners in some cases were active in the GP as defined in the rules governing closely held companies. The
reasoning behind this conclusion was that the partners through their work in the company advising the GP was the main driver in creating value for the investors and that the fact that the partners were not formally employed in the GP didn’t matter. Further, the rules governing closely held companies essentially apply a look-through regime so the fact that the partner in some cases held shares in the GP through a string of intermediaries did not change the conclusion. In summary, the ACA agreed with the STA and the relevant partners were taxed in accordance with the rules governing closely held companies resulting in a substantial increase of the partner’s tax bill.
The structures in the cases decided by the ACA all have in common that they have been around for years without them being challenged. However, in recent years these structures have been challenged in many countries around the globe and the outcome has differed from one jurisdiction to another. For Swedish tax purposes, the cases decided by the ACA dramatically changes the landscape for private equity in Sweden. Right or wrong, things will not be the same.
It is yet unclear if the decisions will be appealed and if the Supreme Administrative Court would then grant leave to appeal. Since the requirement for an appeal to be granted is that the question is one of law as opposed to facts it is
uncertain if this will be the case.
However, one would hope that the Supreme Administrative Court interprets this requirement in the most taxpayer friendly way possible in order for the cases to be tried by the highest court.
It would be prudent for taxpayers in the private equity sector to evaluate the possible tax implications of the rulings, as it may still be possible to avoid tax penalties in certain cases. Stating the obvious, it may also be necessary to reassess the structures for new funds and to restructure current ones (to the extent possible).
Please feel free to contact Christian Carneborn with questions regarding carried interest and the possible effect of these decisions in relation to current and future structures.
The decisions of the ACA (unfortunately only available in Swedish) can be found here.