Since 2012, Norwegian tax authorities have focused on the way Norwegian private equity firms have structured their carried interest payments.

A common private equity structure in Norway is that the management of the private equity firm owns shares in the fund or directly in the underlying portfolio company, through a private limited liability investment company. Carried interest for the management is connected to these shares. Under carried interest rules, buy-out executives have until recently paid relatively low  capital-gains taxes on profits made from buying and selling companies, in the same way investors or entrepreneurs do, as carried interest have mostly been classified as tax exempted dividends or capital gains. This is odd, Norwegian tax authorities have argued, given that the money wagered on private equity buy-out deals mostly come from external investors as opposed to the executives (management)  themselves. It makes more sense for these profits to be taxed like ordinary salaries, they argue, at a significantly higher tax rate.

Thus, in 2012, Norwegian tax authorities began to re-classify carried interest as ordinary wages for the private equity executives, with an effective tax rate of approximately 50% on the carried interest, with payroll taxes on top of that for the employing company, and with the addition of 30% penalty taxes for those who have failed to disclose the factual matters in their tax declarations. This is in line with how Norwegian tax authorities chased for taxes in internal companies in the investment banking sector some few years ago, where the tax authorities argued the same way and actually managed to reclassify approximately NOK 5.5 billion from different investment firms.

In a test case where the tax authorities have reclassified carried interest for the executives in one of the largest Norwegian private equity houses, the management of the private equity house took the tax authorities’ decision to court, with a ruling partly in favor of the executives in the first round. The District Court concluded that carried interest was not wage for the management, but taxable consultant’s fee (and not capital gains on profits from shares) for their investment companies with a tax rate of 28 per cent (a tax rate that is now reduced to 27 per cent).

As expected, the tax authorities appealed the ruling and the Court of Appeal quite recently ruled in favor of the tax authorities. If it becomes binding, the ruling will have a severe impact for the firm’s executives as the total tax cost for the firm and the executives amounts to NOK 294 million, about 90% of the profit they received. The private equity house will appeal the ruling, but it remains to be seen whether the Supreme Court’s Appeal Committee allows the case to be heard by the Supreme Court. If the judgment for any reason becomes binding, it may potentially have severe impact on the taxation of carried interest distributed to Norwegian private equity managers.

Following the ruling from the Court of Appeal, Norwegian tax authorities have stated that they are looking to reclassify carried interest that have been earned in more than 40 different private equity firms. Norwegian private equity firms have however structured their carried interest payments in many different ways, which means that the judgment from the Court of Appeal cannot necessarily be applied equally on the taxation of other private equity firms and their executives.

Norwegian private equity houses worry about the recent development, and warn about the potential impacts if the ruling becomes binding. Norwegian tax authorities have looked to Sweden in these cases, but the Swedish Court of Appeal actually concluded differently in the case the Swedish tax authorities used as a test; i.e. they concluded that carried interest should be taxed as consultant’s fee, not as wages. As Sweden now offers an international competitive tax environment for managers of private equity firms, the Norwegian private equity business fears that Norway will lag behind, and that managers may choose to change their tax jurisdictions. This may in turn result in less risk capital being allocated to Norwegian investments.

This article is co-athored by Partner/Attorney at Law Ernst Ravnaas (ernst@steenstrup.no)