Surprising decision on foreign investment funds – the legislators learn a lesson?

On 18 March the Supreme Administrative Court (HFD) delivered a decision in a case addressing the question of classification of a foreign investment fund. The outcome was not entirely expected and the decision will imply uncertainty in a number of areas.

The decision, testing the appeal of an advance ruling issued by the Council for Advance Tax Rulings, addresses the question of whether an individual is to report a notional income according to Chapter 42, §43 and §44 of the Income Tax Act (IL) for participations held in a Luxembourg alternative investment fund with the legal form of a SICAV, that is, an investment fund comprising a legal entity. The fund in question was a special fund and, consequently, was not covered by the so-called UCITS Directive.

After reviewing both Swedish and European commercial laws and regulations regarding funds, HFD determined, as regards Swedish taxation, the following:

According to Chapter 2, §2 of IL, the terms and expressions in the law shall also apply to equivalent foreign concepts provided that there is no statement regarding, or can be seen to apply in the context, that only Swedish concepts are intended to be covered. According to the preparatory work to IL, the determination is to be made case by case with consideration of, amongst other things, the design and purpose of the tax rules in question.

HFD makes note of a difference existing in the civil law context, a circumstance which, in practice, has been assigned significance, between a SICAV which is a legal entity and a Swedish special fund which is not a legal entity. Then, HFD proceeds to assess whether such a difference may exclude the SICAV from being seen as equivalent to a Swedish special fund.

In its assessment, HFD found that the special tax rules for funds and their investors have had, ever since the special civil law legislation on funds was introduced in Sweden in 1974, to deal with the fact that those (Swedish) funds are not legal entities. The introduction of the AIFM Directive has not impacted the fact that the Swedish funds (securities funds and special funds) are not legal entities but, rather comprise “contractual “ arrangements.

Against this background, HFD determined that a foreign fund which is a legal entity cannot be seen to be equivalent to a special fund in applying the substantial rules found in IL.

It can be noted that the Council on Advance Tax Rulings in the appealed advance ruling came to the opposite conclusion. The Council’s ruling did not adress HFD’s tested aspect of the law but another circumstance, that is, the provision of information to investors.

Comments

The decision results in uncertainty as regards which foreign investment funds that can be seen as equivalent to Swedish investment funds in applying the rules of IL. However, it could be concluded that the outcome of this case does not agree with the intentions of the legislators in their reform of the taxation of funds and investors as introduced on 1 January 2012. The Tax Agency has not, in its statement on what which comprises a foreign investment fund, differentiated between the legal forms but has assigned greater significance to the purpose of the fund and its functional manner and has, therefore, recommended the similar treatment of funds whether they are are contractual, trusts and or legal entities.

Practical problems or questions to address include:

1. Many taxpayers have relied on the assumption that a SICAV cannot be taxed for income in a permanent establishment in Swedish as ”foreign investment funds” are exempt from taxation of income from assets in the fund. The funds that are impacted may need to be restructured.
2. Many taxpayers have declared notional income for holdings of participations in a SICAV and will need to request a reconsideration of their tax assessments.
3. Many taxpayers have assumed that foreign funds other than SICAV’s that are legal entities are also equivalent to Swedish funds and have acted on this basis as regards 1 and 2 above.
4. The refunding of Swedish withholding tax on dividends to funds deemed to comprise ”foreign investment funds” has taken place without any hinder due to that fact that these are legal entities. What will happen with these funds in the future?

The identification of any additional consequences of the decision and how such consequences should be handled requires extensive analysis.