Landmark ruling on carried interest

Sweden lacks specific rules for the taxation of carried interest, which means that the nature of such income must be determined by case law and within the broader provisions of the Swedish Income Tax Act, i.e., as salary or capital income, generally under the rules for closely held companies. 

Over the years, the Tax Agency has repeatedly challenged the capital income treatment of carried interest. In recent practice, the Agency has argued that if carried interest was not paid through the general partner (the "GP"), or if the 3:12 rules were not deemed applicable, the income should instead be treated as salary, leading to significantly higher effective taxation.

The case involved an individual intending to invest in a fund structure, where carried interest was contractually allocated to the initial limited partner (the "ILP"), rather than the GP. 

While the taxpayer and the Tax Agency agreed that salary taxation did not apply, they disagreed on the underlying rationale. The taxpayer argued that the contractual terms should be respected, whereas the Tax Agency contended that the carried interest income should be attributed to the GP for tax purposes, despite the ILP contractually holding the profit share rights. However, since the GP and the ILP were in the same group, this attribution had no tax consequences for the taxpayer. The Council for Advance Tax Rulings sided with the Tax Agency. 

The Court took another position. Drawing a parallel to Swedish limited partnerships, where profit-sharing agreements are generally respected for tax purposes unless they result in improper income shifting or are clearly tax-motivated, the Court found that the allocation to ILP was commercially justified.

Accordingly, the Court held that the carried interest represented a return on investment, not compensation for work. Consequently, no salary income arose for the individual investor.

This decision marks a clear rebuke of the Tax Agency's position over the years. The judgment affirms that carried interest is a negotiated profit share between independent parties and should not be automatically characterised as compensation for work.

From a legal certainty and predictability standpoint, this decision is welcome and should prompt the Tax Agency to reconsider its position in ongoing and future disputes regarding the taxation of carried interest.

Please feel free to contact Schjødt's tax department to discuss any specific queries related to the taxation of carried interest.