Nordic emerges victorious from three-year carry tax battle

Stockholm's appeals court decided to overrule the administrative court's December 2012 ruling - the decision of the tax authority to retroactively tax NC Advisory - in a landmark ruling at 1pm GMT yesterday. In addition to rejecting the tax authority's claims of SEK 702m in employment contributions, NC Advisory will be compensated with SEK 2m for costs in the appeals court, SEK 2.1m for costs in the administrative court and close to SEK 1m for handling fees by the authority. 

"We are relieved that it's finally been thoroughly legally tried," said Joakim Karlsson, managing partner of NC Advisory, who was called as a witness during the hearing at the end of November. "The verdict is in line with our tax lawyers' advice and shows clearly that the tax authority's reinterpretation of the law is not correct; we have paid tax according to existing rules," he said.

According to Karlsson, there was a constructive discussion during the hearing and he labelled the ruling as "super-clear". "Hopefully Skatteverket [the Swedish tax authority] won't be granted another chance to appeal and will shut down its remaining processes [against fellow Swedish buyout houses]," he added.

Carried interest vs. hours worked

The court gave several reasons for its ruling. The resulting document stated that key executives receive carried interest as a reward for investments and therefore defined carried interest as capital gains. The ruling also stated: "There is no direct correlation between the number of working hours spent by the advisory firm and the profit realised when divesting portfolio companies." According to head judge Stefan Holgersson, despite reviewing and investigating a myriad issues relating to the case, in the end the decision centred around hours worked in relation to profits gained.

In the court's view, too many other factors weigh in on investment returns to categorise it as income. "To reclassify capital gains into something else requires legal authority. No such legal authority exists," the court document said.

The hearing was held behind closed doors on 26-27 November. NC Advisory was represented by Sven-Åke Bergqvist, Olle Flygt and Martin Nilsson from Stockholm-based law firm Mannheimer Swartling. Seven legal representatives assisted the tax authority.

"Our interpretation is that the work done by key executives is crucial for carried interest, while the judges focused on the structure of the Jersey-based advisory firm," said Tomas Algotsson, unit head at Skatteverket's legal department. "We will now analyse the verdict," he added.

On the question of whether the authority will continue other processes against large Swedish private equity firms, he said: "Much of the structures are the same, but there could be differences which mean we will look at them on a case-by-case basis." Head judge Holgersson was also unsure as to how the ruling would impact other existing cases against Swedish private equity firms.

Appeal potential

Skatteverket has one to two months to appeal to the final instance, and a group involving Algotsson will now review the possibility of doing so. If the authority does appeal, there could be months until a definitive ruling. Factors such as whether another appeal even remains a possibility add to the time-frame uncertainty. If Skatteverket wins in the final instance, it could mean $600m in back-taxes for Nordic and several hundred million dollars for each of the Swedish buyout firms involved including EQT, Altor, IK, Segulah and Triton. The outcome of the investigation will likely affect personal tax cases too.

"This ruling would logically mean that the process against Altor Equity Partners will not be taken further by Skatteverket," said Altor spokesperson Tor Krusell. "But we cannot be certain until they decide to actually close the case. It is not over until the fat lady sings."

The wider Nordic region will take note of the latest developments, Krusell added: "Norway is our nearest equivalent and has been following this case closely". He went on to say that no other country has ever implemented retroactive carried interest tax. "Sweden is more in line with international praxis now, and investors can breathe more easily," he said.

Most of the funds in question are Jersey-based and have the same LP structures. The verdict will assuage some of the insecurity that has been hovering over the Swedish private equity industry for years.

At the heart of the dispute is whether the activities of Swedish private equity firms should continue being taxed at the current capital gains rate of up to 25%, or at the significantly higher income tax rate of 55%. If it is considered as income, the advisory firm will have to pay employer contributions, which is why that specific question is seen as pivotal.

NC Advisory initially won in the tax committee, Skatteverket's internal ‘tribunal'. But in the first court instance, the administrative court (Förvaltningsrätten) gave Skatteverket the right to define carried interest as income and NC Advisory was sentenced to pay SEK 702m in December 2012.

Key figures of NC advisory have continuously said they were certain the appeals court would rule in their favour in this second round. "In the first instance the court overlooked that what we receive are proceeds from risky investments," said Klas Tikkanen, CFO of NC Advisory.

The relatively mature Swedish buyout industry has been considered a safe haven during the financial crisis, and the sector's importance for the country's overall investment levels cannot be ignored. According to EVCA data, Swedish buyout firms' investments were the largest in Europe last year relative to the size of the country's economy.

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