(2 min read)
We analyse how the formal recognition of carried interest as employment income under Spanish tax law has expanded its relevance beyond taxation into labour law and contractual interpretation. Carried interest is an atypical, performance linked and deferred form of compensation, not equivalent to ordinary salary, with rights accruing only when stringent financial conditions are met.
This is essential for private equity management companies, fund executives, and their legal advisors, who must understand how courts increasingly defer to contractual wording when assessing severance, accrual, or leaver scenarios. The key takeaway: draft carried interest clauses with technical precision, clearly defining conditions, leaver categories, and exclusions, to preserve its intended economic and legal treatment.
The importance of technical precision in carried interest agreements
Since the inclusion in tax regulations of a specific rule for carried interest (via the fifty-third additional provision of the Personal Income Tax Law, introduced by Law 28/2022), this concept has gained prominence in the compensation structure of executives linked to private equity entities.
The law explicitly recognises that carried interest constitutes employment income and anticipates its salary-like nature for executives with an employment relationship. This classification has had effects beyond taxation, giving carried interest a growing labour-law dimension.
This has sparked debate about its salary nature, accrual, impact on severance calculations, and treatment in contractual contingencies such as termination or substantial changes in working conditions.
However, classifying carried interest as employment income (and generally as salary) does not mean it is equivalent to ordinary salary. Legally, salary is a heterogeneous concept that includes multiple forms of compensation, not all with the same nature or effects.
Atypical nature and accrual conditions
Carried interest is an atypical form of salary, directly linked to the profitability of the fund. Its payment is neither automatic nor periodic; it depends on meeting strict, predefined financial conditions that reflect the fund’s performance. Only when these conditions are fully met and the agreed time frame is reached does the executive acquire the right to receive the carry.
This complex nature distinguishes it from other variable compensation or incentive schemes, requiring a differentiated contractual approach.
Case law and the weight of contractual wording
In recent years, courts have begun ruling on the classification and effects of carried interest in executive compensation structures. Although case law is still limited, rulings share a common view: carried interest is extraordinary compensation, subject to specific objectives and generally deferred over the long term.
When determining its economic effects (e.g., inclusion in severance, social security bases, or accrued compensation), courts show strong deference to what was agreed between the parties. This leads to a clear conclusion: the wording and precision of carried interest clauses are crucial.
Ambiguous or generic drafting can lead courts to reinterpret agreements using equity or analogy with other compensation schemes, undermining the essence of carried interest. Therefore, legal treatment largely depends on the contractual precision of these agreements.
Both management companies and beneficiary executives, along with their legal advisors, must pay special attention to drafting these agreements to ensure courts correctly interpret the parties’ intentions and preserve the distinctive nature of this compensation, which is key in the private equity industry.
