German Supreme Tax Court Clarifies "Carried Interest" Taxation

Germany's Federal Fiscal Court (BFH) has issued a ruling that clarifies the taxation of "carried interest" for founding partners in non-trading, asset-managing fund structures. The decision offers significant guidance on how these profit shares are to be classified for income tax purposes.

"Carried interest" typically refers to a disproportionate profit share for the founders of private equity or venture capital funds, received after certain return hurdles are met. The tax treatment of these payments has long been a point of contention with German tax authorities.

The BFH confirmed that "carried interest" should be recognized as a special profit allocation agreed upon in the fund's limited partnership agreement, independent of the invested capital. The court rejected the tax authorities' attempt to reclassify these as remuneration for services to investors, which would be less tax-advantageous.

This latest decision follows the court's 2018 ruling concerning trading fund structures. While the tax authorities had not officially accepted the 2018 decision's principles, this new ruling is expected to increase legal certainty and potentially lead to broader acceptance.

The ruling is anticipated to provide greater clarity and a more favorable tax outcome for founding partners receiving "carried interest" in Germany.