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Advance ruling in Sweden – “carried interest” is taxable as business income
A recent advance ruling by the Swedish Tax Board for Advance Rulings seeks to provide some clarity. Taxand Sweden explores the case.
A Swedish company owned by Swedish individuals is considering to establish a private equity fund through a subsidiary company, “X”. In turn X is to set up (and is the general partner of) a limited partnership within the EU. Limited partners will be external investors, foreign companies resident within the EEA and American pension funds organised as trusts or body corporates.
X will receive compensation at market level for managing the partnership, eg research and analysis of investment opportunities, management of contacts with investors, management of administration and procurement of legal services.
A Limited Partnership Agreement will regulate how the profits of the partnership are allocated among the partners:
- first, all partners to receive a percentage corresponding to each partner’s share of the invested capital, plus 8 percent return
- If there is profit remaining, then X is to be entitled to 20 percent (based on an investment corresponding to 2 percent of the total funds invested) and the external shareholders to 80 percent (based on an investment corresponding to 98 percent of the units). The profit accruing to X which exceeds its share of contributed capital, ie 18 percent of the profit, is carried interest.
The majority of the Swedish Tax Board for Advance Rulings found that the carried interest may be seen as representing X’s part of the profits in the partnership, consisting of return on participating holding, which according to the Swedish tax regulation would be tax free capital income for X . However, the Tax Board further stated that the reason the external investors in the partnership are willing to forgo some of the profit is likely because the partnership is set up by X and key persons in X. The real meaning of the agreement is that the carried interest represents a performance-based compensation to X for its management work in the partnership. The Tax Board’s overall assessment was that the carried interest accruing to X is a performance-based compensation. The carried interest should therefore be taxed as business income in X.
The ruling has been appealed to the Swedish Administrative Supreme Court.
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Also published in Global Tax Weekly, 12 December 2013
The advance ruling supports the Swedish Tax Agency’s opinion that carried interest should not be treated as capital income. It is somewhat surprising that the board uses language that points in the direction of substance over form doctrine. This is particularly surprising given that it is established, and has been accepted for a long time that the partners in a partnership are free to agree on profit distribution between them in a manner they see fit - there is no mandatory correlation between capital invested and share of profits (or losses). An agreement between the partners should be given more importance in a limited partnership than in a limited liability company. It should, however, be noted that the ruling has been appealed to the Supreme Administrative Court that will give a final judgment. The Tax Board’s assessment may therefore be changed.
Pending the Supreme Administrative Court’s ruling, groups should be careful to structure their business in which profit sharing may be linked to a performance under an agreement which may be questioned by the Tax Agency, in the light of the advance ruling.
Taxand Sweden’s assessment is that the question of how carried interest should be treated for tax purposes has not been finally answered and an uncertain legal situation will prevail until the Supreme Administrative Court rules.