Academic journal article Business Law International

The Stockholm Administrative Court of Appeal's Ruling in the Nordic Capital Case - Taxation of Carried Interest

Academic journal article Business Law International

The Stockholm Administrative Court of Appeal's Ruling in the Nordic Capital Case - Taxation of Carried Interest

Article excerpt


On 19 December 2013, the Administrative Court of Appeal in Stockholm announced a much-awaited ruling regarding NC Advisory AB, the Swedish advisory company to Nordic Capital's funds (Case no 8755-8764-12). The question in the case was how the part of the profit split in private equity funds referred to as 'carried interest' should be taxed. The Swedish Tax Agency has scrutinised the Swedish private equity industry, focusing on this issue, since 2007 and in an extensive investigation reassessed almost every Swedish advisory company to larger international private equity funds and individuals employed by these companies. The case against NC Advisory AB is the pilot case and it has thus been closely followed, in Sweden as well as internationally.

In this case comment, the authors briefly describe the private equity structure in question and the case against NC Advisory AB, focusing on the ruling from the Administrative Court of Appeal. The comment concludes with a few observations in light of the ruling.

Private equity funds in question

The funds in the case (Nordic Capital's funds III, IV and V) are similar to Swedish limited liability partnerships (in Swedish 'kommanditbolag') (limited partnership or 'LP'), which are tax resident on Jersey. Prior to the establishment of the respective funds, the founders (the 'key executives') established a corporation (the 'initial limited partner' or ILP) through which the fund establishment is financed and their investments are made. ILP, in turn, established a subsidiary (general partner or GP), which is the manager of the fund. These corporations are also tax resident on Jersey. Both the ILP and GP are parties to the investment agreements entered into with the external investors. In these agreements, the ILP commits to invest capital in the fund and the GP commits to manage the fund. The ILP and GP also agree with the external investors on how the profits in the fund should be allocated between the parties.

The participants in the fund are thus the ILP and GP, on the one hand, and the external investors, on the other hand. The external investors mainly consist of Swedish and international institutional investors, for example, insurance companies, pension funds and government funds. The external investors together invest approximately 98 per cent of the capital in the fund and the key executives (through the ILP) invest approximately two per cent of the capital in the fund.

The GP employs several experienced people. It is the entity that manages and administers the fund and the only entity that may take binding decisions on behalf of the fund (acquisitions and disposals of shares, etc). The GP also has unlimited liability for the fund's activities and obligations. The activities of the GP require authorisation from and are subject to supervision by the Jersey Financial Services Commission. The GP receives a management fee from the fund for its services.

The GP has engaged NC Advisory AB (where the key executives and others are employed), among others, to provide investment advisory services to the GP. For these services, NC Advisory AB receives an advisory fee. The advisory fee should compensate NC Advisory AB on market terms for the work performed. In addition, the GP retains several other advisers such as sister companies to NC Advisory AB in other countries as well as external consultants.

The profits in the fund are allocated between the external investors and the ILP in accordance with pre-agreed principles that are stipulated in the investment agreement. Very simply, first all investors receive a return equal to their investments and a preferred return (interest) calculated on that amount. Thereafter, any excess profits are split between the external investors (80 per cent) and the ILP (20 per cent). The 20 per cent that the ILP receives is the part that is commonly referred to as carried interest. In practice, for carried interest to become distributable, the fund's investments must generate a per annum compounded annual return of at least 13 per cent if costs are taken into consideration (the so-called hurdle rate). …

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