As the effects of the sub-prime crisis in the US continue to reverberate around the world, investors are understandably adopting a more cautious approach. Yet some regions and countries are weathering the current financial storm better than others. Sweden for example, in the Nordic countries, is still relatively unaffected by the credit squeeze, says Gunnar Thuresson, a senior tax partner at Ernst & Young Sweden, and although the government’s current privatisations may be scaled back slightly,  some recent tax court decisions have only served to reinforce the country’s continued attractiveness for investors.

Despite its relatively small size –it has a population of about nine million – Sweden has an impressive roster of economic and business related achievements. In a recent OECD ranking of prosperous nations, for example, Sweden placed no.9, above the UK, Germany and Japan. The country also placed no.1 in the European Union’s European Innovation Scoreboard (EIS) 2007 and no.4 in the World Economic Forum’s Global Competitiveness Report 2007-2008 (from over 130 countries), up from no.9 previously.

Overall other economic fundamentals are relatively sound.  Growth expectations have been cut back in recent months, with growth forecasts of 2.3 percent in 2008 and 2.2 percent in 2009. However, in 2007 Sweden enjoyed considerable success on the employment front with 111,000 Swedes entering the labour force in 2007, reducing full-year unemployment by one percent from 2006 figures, to 6.1 percent, and the number of hours worked increased by 3.1 percent, up to 138.6 million hours per week.

In addition, consumer confidence remains buoyant with January 2008 retail figures up 4.8 percent on the previous year. Plus the Swedish government is sitting on a record budget surplus.

Real estate
One area that should be of interest to investors is the real estate sector.  Sweden has one of the most liquid real estate markets in Europe; so even a very large property investment will remain a liquid investment.

Sweden is the fourth largest real estate investment market in Europe with more than SEK 140 billion (€15.6bn) in total real estate transactions in 2007. By the end of 2007, foreign investors owned real estate assets amounting to more than SEK 210 billion (€23.1bn) by acquisition value, a 300 percent increase over five years. Office and retail property remained the most popular targets for foreign investment.

The outlook for 2008 in the commercial property market remains favourable, says Thuresson. “Real estate rentals are expected to increase, and vacancies are expected to fall further, and while the trend in transaction volume is down slightly over the last three years, the volume is still large relative to the size of Sweden, and we are not expecting volumes to fall dramatically,” he says.  “For the immediate future at least, the story is likely to be rents rising, lower vacancies, coupled with a more selective approach by investors on what to buy, when to buy, and at what price.”

Sweden does not yet offer the equivalent of the Real Estate Investment Trust (which has a special tax status), found in the US and some other EU jurisdictions. Entry into the real estate market is likely to be via a holding company – a limited liability company (AB), or non-resident company – and the taxation regime is a favourable one in this regard.

“From a tax perspective the benefits are that a property sale is very easy to structure as a tax exempt sale,” says Antoine van Horen, Transaction Tax partner at Ernst & Young Sweden. “That is because most property deals done here are in the form of corporate deals –you don’t buy the property, but the shares in the company that owns the property,” says Mr van Horen. “That means it is a tax exempt transaction for the seller, and also, when it comes to the sale, an exempt exit for the buyer. Plus there is a very generous approach to interest deductions. It all adds up to an extremely low effective rate of tax.”

At the moment the rate of return for commercial property investors is somewhere between five and seven percent depending on the type of property (that reflects the yield in the form of rent, rather than any increase in the capital value). Yield expectation in the surrounding countries appear to be 100 basis points or so lower at present.

Privatisation
Another note of interest for real estate investors is the Swedish government’s forthcoming privatisation programme, a key pledge of the government upon its election in 2006.

As part of the programme the government is hoping to sell its 100 percent stake in the property company Vasakronan.  But the sale of Vasakronan is only part of a wider privatisation, where the government has approved or indicated that it will privatise a number of wholly or partly owned government companies. There are six on the list at present which should attract interest from a wide range of potential investors.

The government is still evaluating the timings involved, especially in the wake of current financial market turmoil.  Mats Odell, the minister for financial markets, who is overseeing the privatisation process, recently acknowledged that some reshaping of the original plans may have to take place, including some of the prospective sales being delayed.

So far $2.97bn has been raised from the sale of eight percent of the government’s 45 percent stake in TeliaSonera, the telecommunications company, as well as $363m, from the sale of its 6.6 percent stake in OMX, the Swedish stock market company, to Borse Dubai and Nasdaq.

Forthcoming deals include the sale of Vin & Sprit, the makers of Absolut vodka, as well as banking group Nordea, and mortgage lender SBAB. Although, when referring to SBAB recently, Odell did note, “mortgage lenders are not exactly the top of everyone’s list,” – and the same could be said of banks. Whether or not there are delays in the short term, the intention is for the government to complete the sale of the six organisations by 2010.

Impact of the credit crunch
While the financial markets are going through a period of upheaval, and it is difficult to predict the future with a high degree of certainty, to date there is not much credit crunch related suffering in Sweden.

The credit crunch has had an impact worldwide. All the major international banks have become very careful about counterparty risk and lending, and at the time of writing one major bank, Bear Stearns, had had to be rescued. The effect of this change in attitude towards risk in Sweden and the Nordic countries is that it has reduced activity on very large deals. So deals above $1bn are more difficult to manage because the large foreign banks are more cautious.

“What we have seen both in real estate and in the commercial sector is that where a lot of those deals in the past would have been funded by large foreign banks – Swiss, German, UK and US – we now see less of that,” says Mr van Horen.

“At the same time, however, a more important development at the local level is that local banks do not seem to have suffered from any balance sheet impact, and do not appear to have invested in the problematic US led derivative products. Consequently these banks are less risk averse and are stepping in and grabbing market share. So we are seeing more deals funded by local banks and by equity.”

One reason that the Nordic and Swedish banks may be holding up well is that they learnt some tough lessons at the beginning of the 1990s. In the early 1990s there was a financial crisis in Sweden largely as a result of extensive bank lending to speculative investments. Real estate prices slumped and the Swedish banks suffered very badly. It would be fair to say that without government assistance (a general guarantee of bank obligations) many would have gone under. So the Swedish banks may have been a bit more risk averse this time around.

Taxation
While a general perception exists that Sweden is a country with a high tax regime, on the commercial side nothing could be further from the truth. In fact Sweden has a very favourable tax regime for investors.

At 28 percent, the corporate tax rate is competitive with corporate tax rates across Europe. Factor in the ability to defer – companies can defer a quarter of their taxes every year, for a maximum period of six years – and you end up with an effective annual corporate tax rate of about 21 or 22 percent.

“From a corporate tax perspective, any gains from buying and subsequent sale, for almost all of the parties involved, are tax-free,” says Mr van Horen.  “Capital gains on sale for corporations are almost always exempt, as are capital gains for institutional investors. Transaction costs from the tax point of view are virtually zero. There is no stamp duty on the transfer of shares, for example, as in some jurisdictions, such as the UK.”

The so-called participation exemption for both capital gains and dividends received also means that Sweden is an attractive location as an intermediate holding company, particularly for wider investment into Europe.

Historically, the rules relating to deductibility of interest have also been fairly liberal compared to many other countries in Europe, or elsewhere in the world.

Whereas in many jurisdictions the total debts of the acquisition vehicle, or the consolidated group, can only be a certain percentage of the total balance sheet, (so-called ‘thin capitalisation’ rules), in Sweden there is no limitation at present. This means it is possible to use more debt to fund a transaction, and to obtain greater interest deductions than under most tax regimes.

There have, however, been strong signals from the tax authorities that changes are likely on interest deduction regulations. This stems from a recent tax case in the Supreme Administrative Court, which related to interest deductions.

“The case at hand concerned interest deductions on inter-company loans in connection with a tax driven internal reorganisation. The result of the planning measures was that the tax cost for the group was substantially reduced.  Consequently, the tax authorities challenged that transaction,” says Mr Thuresson.

Initially, the tax authorities obtained a favourable decision from the courts and, as a result, developed a policy to challenge a number of taxpayers on what the authorities perceived as aggressive interest deductions. This caused a lot of concern on the part of tax advisers and big corporations.

“At the end of 2007, the Supreme Court gave its judgment in that case and, in line with the expectations of most tax professionals, gave judgment against the tax authorities, and in favour of the taxpayer,” says Mr van Horen. “The tax authorities then changed their approach, dropped all cases against the taxpayers, and instead have entered into a lobbying process to persuade the government to think about adopting anti-abuse rules around these types of structures.”

Understandably, the tax community is somewhat concerned about the outcome of the lobbying process and how far the government will pursue the interest deduction issue. Will they, for example, look for broader restrictions such as thin capitalisation rules? Mr Thuresson remains optimistic.

“It is not easy to see how the current Swedish government would be persuaded to introduce more general limitations on interest deductions, as we have seen in a lot of other countries, as that would not fit with the government’s liberal thinking with respect to the business climate in Sweden. Based on the current standing of the law, there are very few limits to obtaining interest deductions in connection with investments in Sweden.”

Specialist advice needed
It is clear from developments like the recent decisions on interest deductions by the Swedish courts that it is essential for prospective and existing investors in Sweden to obtain specialist advice. Such as that provided by EY Sweden.

“Our goal is to ensure, whatever the type of activity we are engaged in, that we support clients throughout the whole process – planning, implementation, financing, and finalising the activity,” says Helena Norén, Business Tax Services leader at EY Sweden.

“We try to offer clients a service that goes through the entire lifecycle of the process, which starts with thinking about the investment, supporting them in the financial modelling and tax structuring, supporting them in the due diligence and completion of the transaction, in the integration of the business with the rest of their business, and in the compliance and reporting aspects.”

Because, as Helena Norén notes, a good service for the investor is about more than just the transactional aspects. “We are there for our clients whenever they need us. We take an interest in our clients and invest time with them to understand their business and be able to service them better and in a practical and pragmatic way; to do the right things in the right way.”

For further information
Tel: +46 8 520 590 00
Email: gunnar.thuresson@se.ey.com
www.ey.com/se