Questions often arise in practice with regard to Carry structures and their treatment under the German Capital Investment Code (Kapitalanlagegesetzbuch, "KAGB"). In the following we summarize the administrative practice of the German Federal Financial Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht "BaFin"), taking into account the most recent development:
1. No qualification of the Carry Vehicle itself as investment fund
With regard to Carry Vehicles, the question arises if and when they qualify as investment funds. A qualification as investment fund would formally result in the need to appoint an investment management company (AIFM) with the respective BaFin license or registration to manage the Vehicle.
BaFin answers the question of qualifying as an investment fund in the negative at least if the Vehicle is a so-called "employee participation scheme" (within the meaning of § 2 para. 1 no. 6 KAGB). According to BaFin, this is the case if only "employees" participate in the Vehicle. BaFin views as employees:
- Salaried employees, partners, managers and members of the advisory board of the management company;
- Salaried employees, partners, managers and members of the advisory board of companies affiliated under company law, insofar as they competently and concretely support business activities;
- Former salaried employees, partners, managers and members of the advisory board, which at the time of the participation were employees, partners, managers or advisory board members; and
- Spouses of these employees.
2. Carry Vehicle not treated as investor in the fund (AIF)
The Carry Vehicle is typically participating in the fund as founding limited partner.
Even if the Carry Vehicle should not be seen as an investment fund (but rather as an employee participation scheme, see above), the question arises whether the Carry Vehicle can be seen as an investor to the fund, with the consequence of having to qualify as a retail, semi-professional or professional investor under German law. BaFin regularly denies the qualification as a professional investor. The qualification as a semi-professional investor requires that the Vehicle undertakes to commit at least EUR 200.000 capital contribution to the fund. This requirement will regularly be met in cases where Carry Beneficiaries make the capital contribution to ensure an alignment of interests, provided the capital contribution is made via the Carry Vehicle (which is not always the case). If however such capital contribution by the Carry Beneficiaries is not foreseen for the purpose of co-investments or the Carry Beneficiaries co-invest parallel to the fund, the participation of the Carry Vehicle in the fund will cause the fund to qualify as a retail-AIF (with the consequence that the management company will need to apply for a full license).
BaFin has recently changed their administrative practice regarding this issue and have decided that the Carry Vehicle will not qualify as an investor, provided that
(1) the purpose of the Vehicle's contribution is the collection of profit share, which it receives for the promotion of the purpose of the AIF ("Carried-Interest"),
(2) the entitlement to the Carried Interest is granted under the proviso that the investors have fully received their paid up capital and
(3) a tax consultancy, auditor or law firm has confirmed towards BaFin that in the specific case at hand these requirements have been satisfied.
In such case, BaFin will not view the Carry Vehicle as an investor anymore as the term investor implies that money is being invested for investment purposes.
This however is not the purpose and rationale of the Carry Vehicle's participation. Rather the purpose of the participation is the tax-privileged granting of variable remuneration, not the investment for investment purposes. Accordingly, with regard to the requirements, BaFin takes into account the relevant tax provisions on Carried-Interest-taxation pursuant to § 18 para. 1 no. 4 of the German Income Tax Law (Einkommensteuergesetz).
In all other cases in which the Carry Vehicle will not satisfy the requirements set out above, the administrative practice of BaFin will remain the same, meaning that the Carry Vehicle must make a capital contribution of at least EUR 200.000 to qualify as a semi-professional investor or the investors in the Carry Vehicle must themselves qualify as semi-professional or professional investors by way of a look-through.
3. Relevance for foreign structures
The above-discussed administrative practice is of particular importance for German structures. For foreign structures the only question which arises in connection with Carry Vehicles is whether or not an offer to employees in Germany can be seen as the marketing of an investment fund. This is not the case if an investment fund as under 1) does not exist. In how far the new administrative practice can be made use of in this scenario remains to be seen on a case-by-case basis.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.