Norwegian Court of Appeals: carried interest taxable as employment income
In a landmark judgement, the Norwegian Court of Appeals has ruled that carried interest profit share that can be linked to services provided by employees should treated as taxable income for those employees.
The Herkules case concerned a private equity fund established under a Jersey LLP structure. The services of key individuals were provided to the fund through a management agreement with Herkules Capital, a Norwegian company which employed those individuals. Both Herkules Capital and the General Partner of the fund were owned 60% by personal companies owned by those key individuals and 40% by the private equity sponsor. All profits generated by the fund were split on a fixed basis, with up to 8% of invested capital being paid to ordinary investors and any excess profits being split 80/20 with the General Partner (the ‘carried interest’).
Even though the General Partner provided little or no services to the fund, the Court considered the strong links between the ownership of the General Partner and the working obligations of the key employees, and the fact that the carried interest arrangement was clearly intended as an incentivisation tool. Therefore, the Court ruled that the portion of the carried interest received by the employees’ personal companies should be treated as employment income for the employees and taxed accordingly. Herkules Capital was also held liable for employer’s social security contributions on the same amount. In addition, the Court imposed penalty tax and a penalty contribution of 30% and the taxpayers (the employees involved and Herkules Capital) were required to pay the State’s legal costs.
It is worth noting that the Court disregarded the meticulously structured agreements and legal arrangements, under which no part of the income was actually received by Herkules Capital or the key employees. By taking a high level view about the ultimate intended recipients of the income, the judgement breaks new ground in the “substance over form principle”. Essentially, the Court took the view that the taxable income should be allocated to the parties that are viewed as having provided the work or service for which the amounts were paid.
We expect the judgement to be appealed to the Supreme Court.
Ruling 2015-01-28. LB-2014-048039
For further information or to discuss any of the issues raised, please contact Espen Nordbø on +47 489 90 055 at www.haarvind.no.
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