All You Need to Know About the Swedish CFC Tax Rules

Have you ever thought of starting a company in a low-tax jurisdiction – a so-called tax haven? Incorporating in the British Virgin Islands, Cayman Islands, the Bahamas, or perhaps Dubai (UAE) has long been a popular strategy for international corporations, entrepreneurs, and investors seeking to benefit from low or even non-existent corporate tax.

However, many countries, including Sweden, have implemented so-called CFC (Controlled Foreign Corporation) rules to counter these types of structures.

What are the Swedish CFC rules?

The basic idea behind CFC taxation

The Swedish CFC rules are designed to prevent Swedish taxpayers from shifting profits to low-tax jurisdictions through foreign companies. Instead of waiting until profits are distributed as dividends, the rules can tax certain foreign company profits directly in the hands of the Swedish owner.

This means that if a foreign entity qualifies as a CFC, profits may be taxed in Sweden even if no dividend has been paid. It is not the foreign company itself that is taxed in Sweden, but rather the owner of the foreign company. The owner can be an individual or another company.

Who do the Swedish CFC rules apply to?

The ownership/control threshold

As a main rule, CFC taxation can be triggered if a Swedish taxpayer, alone or together with persons in an interest community, directly or indirectly holds or controls at least 25 percent of the foreign entity’s capital or voting rights at the end of the owner’s tax year.

Holdings through Swedish partnerships are treated similarly to direct holdings, and indirect ownership through foreign entities is also covered.

Interest community can matter

When determining whether the 25 percent threshold is met, Sweden can aggregate ownership held by related parties in an interest community, including certain corporate relationships and certain “related person” relationships under Swedish definitions.

What kind of foreign entity can be a CFC?

Foreign legal entity requirement

For CFC purposes, the foreign entity must be a foreign legal entity under Swedish tax law. A foreign entity that is regarded as owner-taxed (transparent) in its home state cannot be a CFC under the Swedish CFC chapter. In other words, the CFC regime is aimed at foreign corporate-type entities with low-taxed income, not foreign entities that are treated as transparent abroad.

“Control” is broader than legal share ownership

CFC rules are not limited to formal share ownership. The concept of controlling the foreign entity can cover arrangements that provide real influence over the entity’s actions, including certain contractual set-ups. Depending on the circumstances, control considerations can also become relevant in structures involving trusts, foundations, nominee arrangements, or insurance wrappers.

The low-tax condition

The core threshold: 11.33 percent

Even if the 25 percent ownership or control requirement is met, CFC taxation requires that the foreign entity has low-taxed income.

Under the main rule, the foreign entity’s net income is considered low-taxed if it is either not taxed at all, or taxed more lightly than it would have been in Sweden under a specific comparison. The comparison is made as if 55 percent of the net income had been Swedish taxable business profit in a Swedish limited company conducting comparable activity.

With a Swedish corporate income tax rate of 20.6 percent, this implies a low-tax threshold of 11.33 percent (0.55 × 20.6 percent). Put simply, if the effective taxation on the relevant net income is below 11.33 percent, the low-tax condition may be met, subject to the exceptions below.

Net income is computed using Swedish principles

The net income used in the low-tax analysis is computed as if the foreign entity were a Swedish limited company with corresponding income in Sweden. This means that Swedish tax rules determine the taxable base, even though the entity is foreign.

For example:

Limited loss use

Losses can generally only be taken into account for the preceding three years, and only under certain ownership conditions.

Positive net income required

If the foreign entity has a deficit, it is not treated as a CFC for that year. The regime requires non-negative net income.

The “white list” and additional exceptions

Jurisdiction list approach

Swedish law contains a jurisdiction list that can, in many cases, prevent CFC treatment even if the main low-tax test would otherwise be met. If the entity is resident and tax liable in a listed jurisdiction, its income may be treated as not low-taxed for CFC purposes.

In this context, being tax liable does not necessarily mean that tax is actually paid in the specific year.

Financial and insurance income carve-outs

Even where the jurisdiction list would normally protect the entity, certain types of income may fall outside that protection. This mainly concerns:

• banking and financing activities,

• other financial activities, and

• insurance activities.
  

If the income falls within such categories, the white list protection may not apply.

EU/EEA genuine establishment exception

For entities in the EEA, CFC treatment can be avoided if the entity represents a genuine establishment and carries on commercially justified business activity.

When assessing this, particular weight is placed on whether the entity has:

• premises and equipment appropriate for its business,

• personnel with sufficient competence, and

• local decision-making in day-to-day operations.
  

What is the effect of Swedish CFC taxation?

The owner is taxed on the CFC profit

If an entity is treated as a CFC, the Swedish owner is taxed on a share of the entity’s surplus. The taxable amount is computed using Swedish tax rules, and the owner is taxed in proportion to the capital share.

For individuals, CFC income is generally treated as business income rather than capital income, which implies that very high progressive tax rates, 30 - 55% will apply. If the business income is also subject to Swedish Socail Security Contributions, the applicable combined tax and social security rate can reach up to 80%. If the owner is an entity, the applicable rate would instead be 20,6% Corporate Income Tax, as a mainrule.

No Swedish re-taxation on the same profits

If the owner has already been taxed in Sweden under the CFC rules on specific profits, a later dividend distribution of those same profits is generally not taxed again in Sweden to that extent.

Foreign tax credit

If the owner is taxed in Sweden under the CFC rules, foreign taxes paid by the CFC entity can in certain cases be credited against Swedish tax on the CFC income, subject to the foreign tax credit rules.

Concluding remarks

Key takeaways

Ownership threshold

CFC rules can apply once 25 percent ownership or control is reached, including through aggregation with related parties and indirect ownership.

Low-tax condition

A central benchmark is the effective tax threshold of approximately 11.33 percent.

White list and carve-outs

Jurisdiction list protection can apply, but carve-outs, especially for certain financial or insurance income, can remove that protection.

EU/EEA substance exception

EEA entities can avoid CFC treatment if they have a genuine establishment and real business activity.

Taxation of the owner

If the rules apply, Sweden taxes the owner on the CFC’s profits even if no dividend is paid.

Disclaimer

This article is intended for general informational purposes only and does not constitute legal or tax advice. The application of the Swedish CFC rules depends on the specific facts and circumstances of each case, including ownership structure, type of income, and the foreign jurisdiction involved. You should seek professional advice before making any decisions based on this information.

This article has been prepared by Felix Schöttle, Swedish lawyer (LL.M.), specialising in Swedish and international tax law.