Swedish PE industry reeling from carry tax verdict

On 27 April, Sweden's Administrative Court of Appeal (SACA) issued a decision on the taxation of carried interest over the 2007-2012 period in a number of private equity structures, with cases involving firms such as EQT, Altor and Nordic Capital, with the verdict vindicating the Swedish tax authority (Skatteverket). While the private equity industry appeared to score a decisive victory and escape the taxation of carry as income in 2014 after two years of fierce legal battles, Skatteverket's determination to see the cases through eventually came to fruition three years later.

According to law firm DLA Piper, SACA ruled that carried interest would be partly taxed as income from employment and partly as capital gains in five of the cases (Altor, EQT, Litorina, Segulah and Triton), while IK and Nordic Capital employees would see carried interest fully taxed as income from employment.

SACA based its decision on whether carried interest should be taxable as the marginal personal income tax rate because the individuals in question are employees of the Swedish limited liability company that advises the general partner (a common arrangement in Sweden), or taxable as capital income of the limited liability company – in some of the cases settling for a combination of both, as is usually applied to small private company owners in the country.

The ruling is very difficult to understand. It means that on the one hand, carry at some PE houses should be taxed as income, while others will be taxed according to the small companies regime" – Elisabeth Thand Ringqvist, Swedish Venture Capital Association

While ongoing debate around the taxation of carry as income rather than capital gains is widespread across Europe and the US, the stakes are particularly high for the industry in Sweden, where income can be taxed at up to 57% (against 25% for investment gains). Adding insult to injury, the judgement also includes penalties for not having paid the correct amount of tax in the first place.

Local PE professionals have been left stunned by the decision, with the main points of frustration being the retroactive nature of the ruling and the inconsistency of the outcomes. "The ruling is very difficult to understand," says Elisabeth Thand Ringqvist, the chair of the Swedish Venture Capital Association. "It means that on the one hand, carry at some PE houses should be taxed as income, while others will be taxed according to the small companies regime. This creates a lot of uncertainty and raises a number of other questions as well: how will it impact venture capital funds, and beyond that angel investors and even entrepreneurs? And will these rules now apply to the 2012-2017 period as well?"

Last chance saloon
The industry's hopes now rest on bringing the cases all the way to the country's Supreme Court in order to overturn the appeal – but the outcome of this could take some time and still go either way. "All the firms involved will most likely want to get involved in bringing the case to the Supreme Court – but it is not an easy task, as one needs to secure authorisation to have the case examined for a third time, and we are also talking about a large number of taxpayers. All in all, the chances of overturning the appeal will not exceed 50%," says Sven-Åke Bergkvist, a partner at law firm Mannheimer Swartling, which is representing Nordic Capital.

It is not only the firms directly involved in the cases that will keep a close eye on an eventual tie-breaker by Sweden's Supreme Court. EQT head Thomas Von Koch has been vocal in the press about the potentially damaging outcome for Sweden as a whole as an investment destination, and SVCA's Thand Ringqvist agrees: "Some GPs could relocate, yes, but the most negative outcome is that the ruling – if becoming the new norm – will definitely not attract people to Sweden. There is strong competition among European countries at the moment to attract investment funds (as we have seen with Luxembourg more recently), and this is likely to damage Sweden and its economy, beyond the private equity industry itself."

Back in 2014, when Nordic Capital was vindicated as Sweden's Supreme Administrative Court denied Skatteverket's leave to appeal, managing partner Kristoffer Melinder underlined the importance of the victory for Swedish private equity: "It is positive for Sweden that we now have a legal ruling in place that encourages private equity funds, their advisers, as well as international investors to invest in Sweden. Sweden as a country has thereby demonstrated awareness of the private equity industry's value for building a stronger, more enterprising Sweden," he said at the time. Three years later, it seems as if that wave of optimism may have been short-lived.

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