New advance ruling on carried interest

As we have noted in our previous news updates, the taxation of carried interest has been a contentious issue in Sweden for over 15 years, involving ongoing disputes between the Swedish Tax Agency, fund managers and investment professionals. Despite hundreds of cases being reviewed and decided by the Swedish administrative courts, there is still a high degree of uncertainty. In many of the cases, the courts have held that carried interest should be taxed in the same way as dividends on qualified shares in closely held companies, i.e. in accordance with the so‑called 3:12 rules. However, in numerous other cases, the courts have instead sided with the Tax Agency's position, treating carried interest as income from employment.

This new ruling offers valuable insights into the Board's and the Tax Agency's current views. 

The fund in question is a contractual fund without legal personality (the "Fund"), established through a Limited Partnership Agreement (the "LPA") between the general partner ("GP") and the initial limited partner ("ILP"). GP is an opaque entity that manages and acts on behalf of the Fund, employing staff and earning a management fee to cover operational costs. ILP, also opaque, serves as an investment platform. Alongside its investment returns, which are on par with other investors, ILP is entitled to carried interest under the LPA's distribution structure.

All shares in GP and ILP are owned by Holding, a parent company with three share classes: A1 and A2 (preference shares) and B (common shares). A1 shares receive dividends from GP's management fees, while A2 shares receive dividends from ILP's returns on team commitment. The B shares are entitled to the remaining distributable funds in Holding, which effectively means the carried interest received by ILP under the LPA.

GP, ILP, and Holding are all limited liability companies, similar to Swedish limited liability companies. GP qualifies as a closely held company under the 3:12 rules. The applicant is employed by a Swedish advisory company and has been offered the opportunity to acquire B shares in Holding at market value. The shares are subject to standard leaver provisions, requiring a sale of shares if the employment ends. The applicant will acquire the shares through a personal holding company.

The applicant posed two questions: first, whether the income should be treated as salary when paid from the Fund to ILP or from ILP to Holding, and second, whether the distribution from Holding to the applicant’s personal holding company should be treated as salary.

The Board concluded that the returns should not be classified as employment income but should be taxed under the 3:12 rules when the income is distributed from the applicant’s holding company to the applicant. 

The Board noted that it follows from the LPA that the carried interest payment will originate from another entity than the manager of the Fund. According to the Board, the fact that the compensation is allocated to ILP should not affect the applicant's tax situation, given that the carried interest right is redistributed within a wholly owned group. 

Notably, the Swedish Tax Agency concurred with the Board's assessment. They agreed that the allocation of carried interest – defined under the AIFM Directive as a share of the AIF's profits received by the AIF manager for fund management – to a parent company (Holding) owning all shares in ILP and GP did not impact the taxation of the applicant.

One member of the Board dissented, arguing that the distribution from Holding to the applicant’s personal holding company should be considered salary.

As discussed in our previous update (see that article here), the Swedish Government has appointed a designated investigator to review the taxation of carried interest, aiming to clarify the tax treatment. This investigation is expected to present its findings by 20 January 2025.

While the ruling should not impact the outcome of the commissioned review, it is noteworthy that both the Board and the Tax Agency reference the AIFM Directive and its definition of carried interest. Many anticipate that this definition could be integrated into the proposed new rules.