GERMANY Law and Practice Contributed by: Tarek Mardini, Antonia Puglisi and Enzo Biagi, POELLATH
3.6 Taxation of Carried Interest Overview
Management Fee and VAT The Act on Financing of the Future ( Zukunftsfinan - zierungsgesetz ) came into force on 1 January 2024 providing for the long-awaited VAT exemption for the management fees of all German AIFs. This is a key change for the German fund industry. The exemption previously only applied to the management of UCITS, comparable AIFs, and certain venture capital funds. The VAT exemption now applies regardless of the type of regulation of the AIFM and the asset class the AIF is focusing on. Further, in addition to all private equity and venture capital funds, the legislation also includes credit funds, real estate funds, infrastructure funds, any type of fund of funds, etc. At the same time, the qualification of the investors of the fund is no longer relevant. However, unregulated structures, such as single-investor funds (without the flexibility to accept further investors) or “investment clubs” for which no capital has been raised, are not covered by the VAT exemption, as the VAT exemption is linked to the regu - latory qualification as an AIF. This general exemption of management fees from VAT aligns German law with the VAT regulations in most other EU member states, thereby finally eliminating a significant competitive disadvantage for Germany as a fund jurisdiction. 3.5 Rules Concerning Permanent Establishments Germany does not have an exemption ensuring that alternative funds with a German manager do not have a “permanent establishment” or other taxable pres - ence in Germany. This is due to the fact that for funds structured as limited partnerships, the German gen - eral tax rules apply. The German Investment Tax Act – the special tax regime applicable to funds structured other than as partnerships (ie, funds in the form of a corporation or a contractual-type fund) – does provide certain special rules that deviate from the general Ger - man tax rules, but, in effect, it does not provide special rules to substantially limit the permanent establish - ment risk of foreign investors.
The tax treatment of carried interest for fund manag - ers will depend on the legal form and tax status of the fund. The tax treatment of funds structured as partner - ships that are not engaged in a trade or business, that is, that are considered to be engaged in private asset management activities, is well established. These rules apply to the majority of German funds. The rules applicable to other types of funds, in particular, funds structured as partnerships that are engaged in a trade or business, or structured as a corporation or con - tractual-type fund, are less settled, although certain recent developments are encouraging. Carried Interest Taxation Funds structured as partnerships engaged in private asset management Most German funds, in particular direct investing funds, are set up as partnerships and carefully struc - tured to qualify as private asset management activi - ties. Often, fund managers will apply for an advance tax ruling with the German tax authorities to confirm this point prior to the first closing of the fund. Funds that are partnerships engaged in private asset man - agement activities are fully tax transparent (ie, the fund itself is not subject to German trade tax). In addition, a special German tax regime applies to carried interest income received by fund managers, subject to cer - tain technical qualifications (German Income Tax Act Section 18, paragraph 1, number 4). As a result, a certain tax exemption (ie, 40% income tax exemption) applies, which results in an effective rate of income tax of around 28.5% at the level of the individual tax managers (as opposed to the highest personal income tax bracket of 45% otherwise applicable). One of the technical requirements is that the carried interest must be paid only after the investors have received all their invested capital back from the fund. If the specific requirements and qualifications of the special carried interest tax regime are not met, the fund managers’ income in relation to carried interest received could potentially be fully taxable at the respective German personal income tax rate (up to 45%). The highest German fiscal court ( Bundesfinanzhof or BFH) confirmed the above legal assessment and its legal opinion in a ruling in April 2024. Pursuant to
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