Upcoming carry tax ruling further threatens Swedish PE

NC Advisory, the advisory company of Nordic Capital, will attend hearings in Stockholm's appellate court Kammarrätten, defending its practice of declaring profits at the 25% capital gains rate rather than the 56% income tax rate. The advisory firm won in Skatteverket's internal tribunal but subsequently lost in the first instance, Förvaltningsrätten, in December last year. The case is now due to be heard on appeal in the second instance.

Having consulted more than 20 tax lawyers, chief financial officer Klas Tikkanen is highly confident NC Advisory will win the appeal: "There is normally some degree of uncertainty in conflicts like these, but our case is unique in terms of its strength on the merits. Skatteverket is asking for a tax rate of 89%, which is neither reasonable nor sustainable. If it ultimately wins, it's not a good sign for the future investment climate in Sweden."

Since NC Advisory is the first in a line of Swedish private equity houses being investigated, the verdict could set a precedent for other upcoming trials. Tor Krusell, a spokesperson for Altor, which is also involved in the investigation alongside EQT and IK, is deeply concerned: "If a firm like Nordic Capital loses at second level in Kammarrätten, some advisory firms will most likely not be able to cover the tax claims and as a consequence file for bankruptcy."

The upcoming carry tax ruling could have disastrous repercussions for the local PE market

Krusell also believes neighbouring Nordic countries are likely to take note of the Swedish courts' decision. The rest of Europe will also be keeping a close eye on the ruling, as the taxation of private equity and corporations continues to be debated by governments.

The Swedish carried interest battle is two-fold. Partly, it deals with an increased tax assessment for certain individuals within private equity firms; the other point is a related consequence where the firm is being taxed for costs the tax authority believes have been incurred when paying out carried interest to partners at the firms in question.

International attention
While the UK maintains a more relaxed stance (the UK Treasury has said the carried interest issue will "remain under review" since 2012), the controversial tax is being scrutinised in the US, too.

With the so called 3:12 rules, Swedish finance minister Anders Borg has attempted to create a model that benefits private equity in Sweden. But Tikkanen calls for new legislation that creates stable rules for the asset class, with taxation at internationally competitive levels. "This needs to come through the normal legislative process and not be driven by Skatteverket," he says.

Both Tikkanen and Krusell stress how deeply troubling the situation is for the Swedish buyout sector. Says Krusell: "Very few international private equity funds have delivered the same results as those focusing on Sweden and the Nordic countries. Another way of looking at this is by acknowledging that private equity has been a stronger growth engine for business overall in Sweden than in other countries."

Private equity accounts for more than a third of Sweden's foreign direct investments, which is why this sector is seen as critical for the nation's investment levels.

"For the sake of the growth of our economy we must find a way out of this," says Krusell. "Neither the advisory firms, Skatteverket, nor the country gains anything from a prolonged process like this one."

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