Private equity companies say a decision by the Swedish Tax Agency to more than double duties on their carried interest will jeopardize Sweden’s status as an investment haven and could force advisory firms to fold.
The agency will regard the profit-share set aside for fund managers, called carried interest, as salary subject to tax of about 56 percent, rather than as capital income with a rate of about 25 percent. So far, 39 employees at Nordic Capital, IK Investment Partners and Segulah, as well as the companies that advise their funds, face more than 3.3 billion kronor ($500 million) in additional payments, according to documents outlining the back taxes obtained by Bloomberg from the agency.
Sweden has become Europe’s largest private-equity market compared with the size of its economy and 30 percent of all direct foreign investments in the country stem from the industry, according to Nordic Capital. If courts uphold the agency’s view, it would make the country unique and “badly damage” its reputation as an investment hub, said Joakim Karlsson, managing director at Nordic Capital.
“In the unlikely event that the tax authority were to win this case, one would assume that politicians will intervene to create a sensible and competitive tax environment,” Karlsson said by telephone. “If they don’t, I think we’ll see a gradual depletion of the industry where firms that are active in Sweden but who do not need to be here will move somewhere else.”
The Swedish tax agency is demanding 299 million kronor in additional and retroactive taxes from Nordic Capital Partner Robert Andreen, according to the documents. IK Investment Partners’ Executive Chairman Bjoern Saven was told to pay an extra 876 million kronor, while the agency wants 45 million kronor from Segulah Chairman Gabriel Urwitz. Tax records are public and available on request in Sweden.
“If the tax agency’s ruling were to be upheld through the administrative courts, I believe the industry would leave Sweden at short notice and the advisory companies would face de facto bankruptcy because they don’t have and never possessed the funds to pay,” Urwitz said by telephone. “This would lead to chaos in the Swedish private-equity industry.”
The agency on Dec. 20 also decided to charge EQT Partners AB, which is partly owned by the Wallenberg family’s holding company Investor AB (INVEB), an additional 101 million kronor in taxes for 2006, mainly because of carried interest.
EQT declined to comment for this story. The company said in an earlier statement the decision was “wrong and unreasonable” and creates “major insecurity” for EQT’s partners, employees and also for the companies that are owned by its funds. It will appeal the charge, the company said.
IK Investment Partners declined to comment on the ruling on behalf of its employees, which includes Saven. Nordic Capital’s Karlsson commented on behalf of the company and its partners.
Last year’s U.S. presidential campaign focused attention on the taxation of private-equity managers as Republican nominee Mitt Romney, the former head of Bain Capital LLC, built his wealth in the industry. Romney’s 2011 tax return showed he paid a 14.1 percent federal tax rate on $13.7 million of income because much of this was taxed at preferential rates.
Carried interest is often taxed as capital gains in the U.S with the top rate on long-term gains, now at 15 percent, below levies on ordinary income. The rate is set to rise to 20 percent this year.
Some 85 percent of investments in Swedish private-equity funds are foreign, according to the Swedish Private Equity & Venture Capital Association. Many of Sweden’s private-equity funds have had “world-class” returns in recent years and the country has become a haven for investors seeking investments in a Europe that is characterized elsewhere by lackluster growth and concern about the euro’s future, said Marie Reinius, the association’s head. Any uncertainty about future tax regulation puts Sweden at a disadvantage, she said.
“You enter 10-year agreements when you invest in a private-equity fund and it’s important to know what you get, which is why we need clear long-term tax rules that are competitive from an international perspective,” she said. “International investors are crass -- they look at where it will be best for them to invest.”
If the tax agency wins its case, some private-equity companies will probably move away from Sweden and new funds are unlikely to be set up, Reinius said. Swedish companies will lose out if private equity funding disappears, while the 2,000 lawyers and consultants that sell services for 4.5 billion kronor annually to the industry will suffer, she said.
“Ultimately, we believe the courts will overturn the ruling, but the dilemma for the industry is that an appeals process could take five to 10 years, during which time private equity in Sweden would face monumental uncertainty,” said Segulah’s Urwitz.
The companies argue that the agency’s stance has no legal basis and that politicians should decide on rule changes, rather than have tax authorities make adjustments and then have them tried in court. NC Advisory, the company that advises Nordic Capital funds, has seen its 702 million kronor in retroactive taxes upheld by Stockholm’s administrative court, and other similar cases are pending.
Nordic Capital, which manages some 9 billion euros ($11.9 billion) in its funds, will appeal the ruling, arguing that profit in a fund consists of return on invested capital that is then allocated to the fund’s investors, according to a statement on its website.
The decision also undermines confidence in Swedish regulation and hurts the entire investment climate in Sweden, said Sven-Aake Bergkvist, the Mannheimer Swartling lawyer in Stockholm who represents NC Advisory in the case.
The agency’s decisions are legal, said Goran Haglund, a tax accountant at the authority and the previous coordinator of the investigation of private equity firms that started in 2007. The agency noticed large transactions and that some funds were based in countries that then were considered tax havens, such as Guernsey and Jersey, he said.
“This indicated that there might be a big risk of tax errors, which is why we started an investigation that has led to our stance and decisions,” he said. “There is a difference in taxation on capital income and work income, but if the pay relates to work-performance then it should be taxed as work, or in other words, regarded as a salary.”
If appeal courts uphold the ruling, total taxes on carried interest in Sweden would rise to 67 percent, including social security contributions, from between 25 percent and 30 percent today, Nordic Capital’s Karlsson said. The average tax on carried interest is 25 percent to 35 percent in the rest of Europe, apart from in Denmark, where it’s 56 percent, he said.
The buyout industry saw 21 investments valued at 8.48 billion kronor in the third quarter, according to data from the private equity association, down from 34 transactions worth about 19 billion kronor a year earlier and roughly on par with 8.29 billion kronor in the second quarter.
Some 7 percent of all employees in the private sector in Sweden, or about 180,000 people, work at companies owned by private equity companies, according to the association. The annual turnover of Swedish companies that are owned by private equity firms is about 250 billion kronor, which represents 8 percent of the country’s economic output, it said.
Although private equity is unlikely to disappear from Sweden if the tax agency wins, the country’s popularity among foreign investors will take a hit, said Karlsson.
“All funds with a Swedish connection are now forced to talk to their investors and tell them what’s going on and try to explain this rather Kafkaesque tax situation,” he said. “That tax authorities after 20 years can change an accepted principle, retroactively, will confuse many investors a lot and they will of course draw parallels to other investment alternatives. It’s impossible to quantify how big the contagion would be.”
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