Photographer: Casper Hedberg/Bloomberg

Why Sweden Killed the Carried Interest Tax Break: QuickTake Q&A

Private equity partners in Sweden are reeling from a court decision that ends the tax break known as carried interest. Sweden is not the first country to target the widely reviled exemption, which lets some high-income fund managers pay taxes at a lower rate by counting their earnings as capital gains rather than salaries. The ruling, which could force some managers to pay back taxes on profits earned a decade ago, puts Sweden Inc. at loggerheads with the state and may even lead some firms to leave the country. Sweden’s tax agency, which pursued the case for years, says bringing clarity to what had been a tax muddle will be good for everyone.

1. Why did Sweden end the tax break?

The Swedish tax authority argues that payments to private equity partners are partly based on their performance as managers and not just a result of passive investment returns. That means the money should be treated as salary, rather than capital gains, which are taxed at a lower rate to encourage people to put their money at risk by investing it. The latest ruling means the government will get at least 2.3 billion kronor ($260 million) more in back taxes.

2. Who’s affected?

The ruling affects about 85 private equity partners directly, and sets a precedent for hundreds of other cases. But funds argue that it will have more far-reaching implications for investments by an industry that manages holdings equivalent to about $51 billion, or 11 percent of Sweden’s gross domestic product. The companies that Sweden’s private equity industry invests in employ some 200,000 people in a country of about 10 million.

3. What has the response been?

Sweden’s private equity industry says its main complaint is the unpredictability of the business environment. Thomas von Koch, the managing partner who runs EQT AB (Scandinavia’s biggest buyout fund, which was co-founded by the Wallenberg family’s Investor AB) says the ability of the tax authority to impose taxes retroactively, as in this case, could make life in Sweden untenable for his industry. This is just the latest clash between private enterprise and the state. Nordea Bank AB, Scandinavia’s biggest lender, is considering moving its headquarters out of Sweden unless the cost of banking there is cut.

4. How long has this fight been going on?

The decision reverses a 2013 ruling in which private-equity funds prevailed. The tax authority asked courts to retry the case, based on new arguments, to claim higher tax payments for the years 2007 to 2012. The matter may still go before Sweden’s Supreme Administrative Court.

5. Haven’t other countries changed the rules?

Yes. In 2016, the U.K. tightened regulations and began taxing carried interest at a higher individual rate of 40 percent for private equity funds that hold their investments for less than 40 months. Since 2004, Germany has required managers to pay ordinary rates of up to 47.5 percent on 60 percent of their carried-interest profits, with the rest tax-free.

6. What about the U.S.?

When President Donald Trump was campaigning, he said the carried-interest exemption lets rich managers "get away with murder” and vowed to close it. But the outline of a tax plan the White House released in April makes no mention of carried interest and would reduce the tax rate for most partnerships to 15 percent, less than private-equity managers now pay.

7. What’s the main dispute over carried interest?

In the different countries where it’s been been debated, opponents of the tax break argue that carried interest is simply remuneration for the work involved in growing a company that a fund has invested in. They say that preferential long-term capital-gains treatment should be reserved for investors who risk their own money. Supporters of a tax break argue that carried interest is akin to “sweat equity” because fund managers are entrepreneurs who take on the risk of raising money from outside investors and putting the dollars into companies that might not pan out.

The Reference Shelf

  • A QuickTake explainer on the carried interest tax break. 
  • Why Nordea Bank is threatening to leave Sweden.
  • U.S. tax lawyer Victor Fleischer wrote an influential 2008 research paper that called to end the tax benefit. He is now co-chief tax counsel for Senate Finance Committee Democrats.
  • The Tax Policy Center, a think tank under the Urban Institute and Brookings Institution, has a simple, balanced guide -- call it "Carried Interest for Dummies."
  • The American Investment Council, the lobby formerly known as the Private Equity Growth Capital Council, defends the tax benefit as a driver of economic growth.
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