Carry

Explanation of the term and legal definition of “Carry”

Basic meaning of the term Carry

The term “Carry” (in German-speaking countries often described as profit participation, performance participation, or performance fee) originates from the English-speaking finance and business sector. In a legal context, Carry primarily refers to the contractually agreed participation of certain parties—typically managers or initiators of companies—in the financial success of investments, funds, or other assets. In particular, Carry stands for the proportional share of the profit achieved that exceeds an initial base hurdle.

Historical development and legal classification

The term originated in Anglo-Saxon law, especially in connection with private equity and venture capital funds. It was subsequently adopted into German and European legal systems, with its legal structure adapted to national contract and corporate practices.

Original model: Private equity and venture capital

In the private equity and venture capital sector, Carry classically refers to the remuneration of fund managers for the successful management of fund assets. Legally, Carry is bindingly regulated in fund documentation such as partnership agreements (Limited Partnership Agreement, Kommanditgesellschaftsvertrag) or investment guidelines. In contrast to a pure management fee, Carry is based solely on the fund’s performance record and is only due once a certain return threshold (“hurdle rate”) has been reached.

Legal structure and contract design of Carry

Civil law foundations

Under German civil law, the allocation of Carry is regularly based on contractual or corporate law agreements. Key points of regulation include:

• Amount and calculation basis for Carry (usually a fixed percentage, e.g. 20% of additional profit)
• Eligibility requirements (usually after exceeding the hurdle rate or “preferred return”)
• Modalities for profit determination and distribution
• Timing components of payout (interim distributions, distribution cycles)
• Repayment rights and clawback clauses for adjustment in the case of subsequent losses

Sample clauses in the partnership agreement

Typical provisions are found in fund limited partnership agreements or shareholder agreements. These define, among other things, which managers (e.g. general partner, managing partner) are entitled to Carry and under what conditions.

Tax treatment of Carry

The tax treatment of Carry is a complex topic within the profit distribution of companies and funds. Under German tax law, Carry is generally classified as income from commercial operations. Key questions arise regarding the distinction from income from employment or from investment income, particularly in the allocation to individuals or corporations.

Tax structuring options

• Capital gains tax versus income tax
• Entrepreneurial initiative and entrepreneurial risk as tax prerequisites for preferential assessment
• Design of carried interest structures under international tax law (BEPS, double taxation agreements)

Carry in the context of different company forms

Limited partnership (KG) and Carry

In German private equity or venture capital funds, limited partnerships (KG or GmbH & Co. KG) are often used as fund vehicles. Here, Carry is allocated to the general partner or certain contributing limited partners. The contractual foundations arise from the partnership agreement and any side agreements (“management participation agreements”).

Alternative investment funds (AIF) and investment legislation

Within regulated investment vehicles such as alternative investment funds (AIF), Carry is subject to the requirements of the European AIFM Directive and to national investment laws, such as the German Capital Investment Code (KAGB). These regulations stipulate transparency and disclosure obligations regarding remuneration systems, including Carry, and set requirements relating to conflicts of interest and investor protection.

Carry in other legal contexts

Employment law relevance

In certain situations, Carry can also be agreed as a variable remuneration component for employees in management positions. This gives rise to references to employment contract law as well as to participation rights under works constitution law, particularly regarding transparency, eligibility criteria, and proof obligations.

Insolvency law aspects

In the event of insolvency of a fund or fund company, the question arises as to how to treat Carry amounts already paid out. These may, under certain circumstances, be considered gratuitous transactions or detrimental actions within the meaning of the Insolvency Code (InsO) and subject to insolvency clawback.

Disputed issues, case law and practical problems

Demarcation issues

In legal practice, the following points are particularly contentious:

• The tax classification of Carry income
• Effects of interim withdrawals (escrow or reserve accounts)
• Reversal clauses for later realized losses (“clawback”)
• Impacts of supervisory requirements and transparency obligations

Current developments and case law

Numerous tax and company law disputes are regularly addressed by tax courts and civil courts, especially regarding the tax qualification and insolvency law treatment of Carry. Decisions at the European level also concern regulatory issues on remuneration in investment funds.

Summary and outlook

The term Carry under law refers to performance-based remuneration, especially in investment and fund contexts, and is subject to extensive civil and tax law regulations. The precise legal design depends on the individual contractual agreements, the chosen entity structure, and the applicable regulatory and tax requirements. The complexity of Carry provisions requires careful contractual arrangement and attention to current legal developments in practice, particularly regarding transparency requirements, tax obligations, and liability issues.

Frequently Asked Questions

How is Carry taxed in private equity funds in Germany?

The taxation of “Carry” (carried interest) in connection with private equity funds in Germany is shaped by various rules that mainly depend on the particular circumstances and the specific design of the fund, the parties involved, and the profit-sharing model. As a rule, Carry represents performance-related remuneration for fund managers that goes beyond actual capital participation. For tax purposes, Carry may be classified as business income (§ 15 EStG), or less commonly as other income (§ 22 No. 3 EStG), or as investment income (§ 20 EStG). The decisive factor is whether the fund is to be regarded as a commercial or asset-managing entity and whether the fund manager qualifies as a co-entrepreneur. For typical German private equity funds, usually structured as a GmbH & Co. KG, Carry is routinely classified as business income and is therefore subject to personal income tax and, where applicable, trade tax. Taxation generally occurs upon receipt of the Carry (“receipt principle”). For alternative scenarios—such as cross-border structures or managers with no entrepreneurial status—the particular rules of the AStG and double taxation agreements must be considered. The tax classification may be altered by new statutory frameworks or administrative decrees, which is why ongoing review is advisable.

What legal framework determines the eligibility requirements for Carry?

The entitlement to Carry arises primarily from contractual provisions, especially the partnership agreement (Limited Partnership Agreement, Kommanditgesellschaftsvertrag or comparable fund documents). Legally, Carry is a claim for profit-sharing based on contract or corporate law, which as a rule becomes due after repayment of contributed capital and after a minimum return (hurdle rate) has been achieved for the investors. A prerequisite for acquiring a Carry claim is generally the fulfillment of certain conditions, such as full repayment of investments and, if applicable, reaching further contractually defined thresholds. The precise design typically follows internationally recognized market standards, but is individually negotiable. In Germany, mandatory corporate law provisions (especially §§ 705 et seq. BGB, § 161 HGB), employment law considerations for employed fund managers, as well as regulatory requirements of investment law (German Capital Investment Code – KAGB) must be observed. Depending on the structure, Carry may also be subject to insolvency law restrictions or clawback clauses.

What role do regulatory requirements under the KAGB play for Carry beneficiaries?

The Capital Investment Code (KAGB) contains various provisions with direct and indirect effects on carried interest payments. For managers of alternative investment funds (AIFM), the law provides reporting requirements, remuneration transparency, and governance regulations that are also relevant to carried interest rules. In particular, Chapters 2 and 5 KAGB set minimum standards for remuneration policies aimed at limiting incentives for excessive risk-taking and excluding conflicts of interest between management and investors. Carried interest must be disclosed as variable remuneration in the remuneration report and structured in line with regulatory objectives. For Carry recipients, there are also special requirements concerning insider trading, market abuse, and, where applicable, licensing obligations under the KAGB or the German Banking Act (KWG), especially if Carry payments are combined with further bonuses.

How are carried interest agreements legally assessed in the event of fund insolvency?

In the insolvency of a private equity fund, carried interest agreements are to be treated according to the general insolvency law provisions. This means that Carried Interest claims that are not yet due or not yet fully earned must be registered as ordinary insolvency claims (§ 38 InsO). If Carry payments were made before the insolvency, the insolvency administrator examines their contestability pursuant to §§ 129 ff. InsO, particularly regarding any unlawful disadvantage to other creditors or gratuitous services. Repayment obligations (clawback) remain, as a rule, effective even in insolvency and can be asserted by the insolvency administrator should subsequently loss-making transactions or errors in the hurdle calculation emerge. The access, security, and legal validity of Carry claims in insolvency depend primarily on the contractual structure (especially their conditionality, subordination, and ranking).

Are Carry agreements subject to co-determination or approval requirements under employment law?

Whether and to what extent Carry agreements are subject to co-determination by the works council or other bodies depends on whether the eligible persons are employees of the fund or management company, or corporate partners. For classic partner companies (GmbH & Co. KG, LLP, etc.), Carry payments are not subject to works constitution law co-determination rights, as they are structured under corporate law. For employed fund managers entitled to Carry, however, the issue of collective co-determination under the Works Constitution Act (BetrVG) or an individual consent requirement—e.g. under § 87(1) No. 10 BetrVG (company pay)—may certainly arise. Depending on the remuneration model and its transparency, employment law claims (equal treatment principle, control of bonus rules, integration into overall remuneration concepts) may be triggered.

Are there special disclosure or reporting obligations in connection with Carry?

Yes, legally, various disclosure obligations must be observed, arising from national law (e.g. Commercial Code, Capital Investment Code) and international standards (such as AIFMD). Fund managers must explain the structure, calculation method, and payment mechanics of carried interest in annual financial statements and investor reports. Transparency for investors regarding fees, costs, and performance-based components is mandatory. For retail funds or publicly distributed alternative investment funds, additional information requirements under the German Investment Act (VermAnlG) or the requirements of BaFin and the European SFDR must be observed. Non-compliance with these disclosure obligations may result in regulatory sanctions, investor claims, or also liability consequences for management.

How do double taxation agreements (DTAs) affect the taxation of Carry?

Double taxation agreements (DTAs) are decisive in determining which country has the right to tax cross-border investments and Carry payments. In international private equity business, connections with several countries are common—for example, regarding the fund’s domicile, management, investors, and Carry recipients. DTAs typically provide that income classified as business profits or service-related income is taxed in the country of residence of the service provider (usually the Carry recipient), but may contain different rules for source taxation (fund state). Depending on the structure, it must be verified in particular whether Carry is classified as salary, self-employment income, or investment income. The practical implementation depends on the precise terms of the respective DTA, German treaty law decisions, and any certification or documentation requirements. Inconsistencies or misclassifications can lead to double taxation risks or even loss of relief claims.