Sweden tax: Government proposes changes to taxation of prohibited loans

The Swedish government submitted a bill on 30 September 2009 that would amend the rules governing the taxation of certain "prohibited loans" and disallow the deductibility of interest on such loans. Unlike previously proposed changes, however, the new bill includes an exemption for loans granted to limited liability companies, which would limit the negative effects of the rules in connection with intragroup financing.


Background

This proposal targets a tax avoidance scheme that the government claims will result in significant losses in tax revenue if not addressed. The scheme works as follows: the owner of a Swedish active company establishes a foreign company (usually in Cyprus, Luxembourg, the Netherlands or Malta), which then acquirers the shares in the Swedish company. This transaction, in general, will not lead to any Swedish tax consequences. Once the new structure is in place, the Swedish company can distribute capital to the foreign holding company or issue an intragroup loan to the company (provided it is exempt from the main rule on prohibited loans). The Swedish owner of the foreign holding company can then lend the capital from the foreign holding company. Had a direct loan been made from the Swedish company, it would have been subject to tax.

The new bill would equalize the tax treatment of loans from foreign companies with loans from Swedish companies by bringing loans granted by a foreign entity within the scope of the rules on "prohibited loans."


Current legislation

The Swedish Companies Act generally prohibits a Swedish limited liability company (AB) from granting a loan to certain related parties, such as a shareholder, board member, CEO or a person closely related to these persons. Loans granted to companies that are directly or indirectly controlled by any of these persons also are prohibited. According to the Income Tax Act, prohibited loans are deemed to constitute taxable income of the borrower. The borrower is taxed on the amount of the loan received, e.g. if the recipient is a limited liability company, the loan is business income; if the recipient is an individual, the loan amount is considered earned income; and in the case of a partnership, the partners will be taxed individually. The right to deduct interest on prohibited loans, however, is unlimited (provided no other restrictions apply to the loan).


Proposed legislation

The proposed rules would expand the reach of the concept of prohibited loans to include loans from foreign related legal persons and loans provided by Swedish or foreign persons to foreign persons that are fiscally transparent. The proposed rules also would encompass the taxation of partners in a partnership that, through the holding of one or several partnerships, hold a partnership that has received a prohibited loan.

Additionally, the right to deduct interest on prohibited loans would be abolished for both Swedish and foreign loans. Interest on such loans would not deductible, regardless of when the loan was granted. Further, the total amount of outstanding prohibited loans would be included in the income of a person who directly or indirectly, through one or more Swedish partnerships, is a partner in the borrowing Swedish partnership. This rule would apply only to prohibited loans granted after 12 February 2009, with the current rules continuing to apply to loans granted before that date. As noted above, loans granted to limited liability companies would be excluded from the measures.


Effective date

If approved, the new rules are proposed to come into effect on 1 January 2010. However, the government has noted that there are special reasons for the amendments to apply retroactively as from 13 February 2009. The interest deduction restrictions are proposed to also apply to loans granted before 13 February 2009. Any interest payments made prior to 13 February 2009 are not covered by the new rules.