GERMANY Law and Practice Contributed by: Tarek Mardini, Antonia Puglisi and Enzo Biagi, POELLATH
the ruling, carried interest is a capital disproportion - ate share of profit and does not constitute a hidden service fee ( Tätigkeitsvergütung ). As a result, carried interest remains subject to the privileged taxation pur - suant to Section 18 (4) of the German Income Tax Act. Private investors in private asset management funds, in particular, benefit from the decision of the court, as carried interest should reduce their taxable income, since the expense deduction limitation rule pursuant to Section 20 (9) of the German Income Tax Act does not apply. The decision was confirmed by the Munich fiscal court in August 2025. It remains to be seen if and how the German tax authorities will now ultimately apply the general prin - ciples of the ruling in practice. Funds structured as partnerships engaged in a trade or business Some funds are structured as partnerships that are engaged in a trade or business. This might be the case because some institutional investors prefer that the fund is engaged in a trade or business, or because the respective fund strategy is seen to be more active than a typical private equity fund (eg, turnaround funds or venture capital funds acting as incubators). In such cases, the German tax authorities have taken the position that the carried interest received by the fund managers is subject to the respective German personal income tax rate (up to 45%), that is, that the special tax exemption for funds qualifying as private asset management is not applicable. This is due to the fact that the tax authorities consider the carried inter - est to be a “hidden payment” for services provided by fund managers to the fund rather than a capital-dis - proportionate participation in the distribution waterfall among partners of the fund. However, the German highest tax court issued a rul - ing in a case from late 2018 which disagrees with this tax treatment. According to the court, the waterfall distribution rules in fund agreements that set out the distribution of profits received by the fund among all partners of the fund have to be respected. In oth - er words, the court considers that carried interest
received should not be characterised as a “hidden payment” for services provided by fund managers to the fund. Rather, the court ruling qualifies such pay - ment received by fund managers as a (capital-dis - proportionate) share of the profits. Therefore, the so- called partial income rule, which exempts 40% of the income and makes only 60% of the income received subject to the normal individual tax rate, will also be applied by the court in cases where the fund qualifies as being engaged in a trade or business. This results in a tax rate of around 28.5% at the level of the indi - vidual tax managers. This ruling greatly reduces the risk for fund managers that a change in assessment by the tax authorities of the fund activities (trade or business versus private asset management) would negatively affect their tax position with respect to car - ried interest. The recent ruling of the German highest tax court of 2024 (as described above) can be seen as a confirmation for the core legal reasoning. 3.7 Outsourcing of Investment Functions/ Business Operations Outsourcing by fund managers is possible and is com - monly used. If portfolio management or risk manage - ment is outsourced, the delegate must have a licence (as required by the AIFMD). Outsourcing agreements are often based on a sample agreement published by a German investment lobby group called BVI ( Bun- desverband Investment und Asset Management eV ). Outsourcing agreements must ensure specific control and supervisory rights by BaFin and by the fund man - ager’s internal control functions. Pursuant to AIFMD II, the reporting and transparency obligations towards managers that use outsourcing will be increased. Under the new law, managers will be required to provide detailed reporting of their out - sourcing activities including the volume of outsourcing as well as the actual outsourced activities. 3.8 Local Substance Requirements See 2.8 Local/Presence Requirements for Funds .
3.9 Change of Control Fully Authorised Managers
Fully authorised managers must notify BaFin – to the extent they become aware of the impending change – of the following:
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