The Swedish Supreme Administrative Court on taxation of Carried Interest

The Supreme Administrative Court (SAC) has passed a judgement regarding taxation of so called carried interest. The judgement brings an end to almost ten years of investigations and legal proceedings. The position of the Swedish Tax Agency (STA) was affirmed, and taxation finally set to a significantly higher level than claimed by the tax payers.

Background

The legal proceedings concern a number of individuals acting as investment advisors, decision makers etc. within private equity funds. These individuals have in different ways received remuneration in relation to a certain profit share – carried interest – paid from the funds. Typically, the carried interest has been paid to the individuals through holding companies.

In years when the funds were successful, the investments in carried interest were successful too.

The individuals receiving carried interest generally treated the remuneration as capital income in their income tax returns, i.e. taxed at 25 percent (capital gains or dividends on so called unqualified shares in closely held companies). However, this was not accepted by the STA which took the position that this kind of remuneration should be taxed significantly higher.

Initially the STA argued that carried interest should be regarded as salary for the individuals in question and therefore taxed as employment income, regardless of whether the individuals had actually received carried interest directly or indirectly by way of payments to companies owned by them or not. This approach would lead to a tax rate close to 60 percent plus social security contributions.

The first legal proceedings on this concerned the obligation for the individuals’ employers to levy social security contributions on carried interest. In 2012, the administrative court judged in favor of the STA in a case against NC Advisory AB (Nordic Capital), and ruled that carried interest should be regarded as compensation for work performed by the individuals and thus be subject to social security contributions. However, this judgement was set aside by the Administrative Court of Appeal in Stockholm in a judgement from December 2013.

According to the administrative court of appeal, carried interest could not be considered as compensation for work performed by the individuals. The STA appealed the judgment to the SAC. On 5 November 2014 the SAC decided not to grant a leave to appeal.

After this, the STA changed its position in the proceedings. Instead of claiming that carried interest should be taxed as salary the STA claimed that dividends and capital gains from the companies which had received carried interest, should be taxed according to the rules on qualified shares in closely held companies, which means that part of the income should still be taxed as employment income.

The Administrative Court and the Administrative Court of Appeal in Stockholm ruled in favor of the STA. The courts considered that the prerequisites for applying the rules on qualified shares in closely held companies were met, i.e. that the individual in question had been active to a significant extent in a closely held company. The fact that the individuals had not been employed by the so called General Partner of the fund, i.e. the company conducting the business which gave rise to carried interest, did not change the assessment. Instead the administrative court of appeal considered that the advisors, decision makers and similar participants within the funds collectively had been of significant influence for generating profits in the business run by the General Partner. As a consequence each one of them should be regarded as active also in that company.

The judgement from the SAC

The vast majority of the tax payers have appealed the judgements from the administrative court of appeal to the SAC. The SAC granted leave to appeal in one case regarding an employee at EQT and stayed the proceedings for several other cases with similar circumstances during winter 2018.

SAC announced that it was the following question that was to be addressed by the court:

“Can an individual be considered as active to a significant extent in a closely held company when the individual is employed by another closely held company and within the scope of this employment performs services for the first company?”

The SACs answer to this was yes. An individual can thus be considered as active to a significant extent in a closely held company even though he or she is not employed by this company but by another company which provides services to the closely held company.

The question addressed by the SAC is only one of several prerequisites which have to be fulfilled in order for the rules on qualified shares in closely held companies to apply. An individual shall further only be considered as active to a significant extent in a closely held company if he or she has been of significant influence for generating profits in the business of the company. However, this question was never assessed by the SAC, since the SAC considered that such an assessment was not necessary in order to answer the question which had been granted leave to appeal. The other parts of the case was never granted leave to appeal, thus the ruling from the administrative court of appeal stands.

Comments

The ruling from the SAC clarifies how the question which was granted leave to appeal should be assessed. An individual can be considered as active to a significant extent in a company that he or she performs services for within the scope of the employment in another company. This conclusion clarifies a principle that has begun to take shape in case law (see HFD 2013 ref. 11).

However, it is not evident that this case should be treated the same way as HFD 2013 ref. 11, since the circumstances in the previous case were quite specific. The individual in that case was the only official in the profit generating company, and thus had a total influence over the profit generation. The individuals in the carried interest proceedings have often played much less influential roles, active to different degrees and in different companies. The administrative court of appeal’s assessment on a group of individuals’ – active in different companies – influence on the generation of profits in one company to which they render services at arm’s length terms, is not something we have seen before in case law.

It would obviously have been very valuable to have the SACs assessment on this issue too. However, since that question was not granted leave to appeal we will not learn if the assessment of the administrative court of appeal was correct in this regard.

When the ruling from the SAC was announced, it was also announced that a large number of other tax payers were not granted leave to appeal by the SAC. We have not yet been able to determine whether this is the case for all of the tax payers who have appealed to the SAC or if there are exceptions where leave to appeal have been granted. It is however likely that the legal proceedings are now over.

Per Holstad och Ida Larsson

Kontakt
Per Holstad
072-206 46 99

 

Kontakt
Ida Larsson
070-382 21 87