Government update on the tax treatment of carried interest: what private capital professionals need to know

The UK government has recently published a Response and Policy Update following its Call for Evidence on the tax treatment of carried interest, providing crucial clarity and detail on forthcoming reforms. These changes will significantly impact fund managers, in-house tax functions, and other professionals operating in the private capital industry.

This blog post breaks down the key points of the update, helping you understand what to expect and how to prepare.

Background: Key Changes to Carried Interest Taxation

• From 6 April 2025, the capital gains tax (CGT) rate applicable to carried interest for higher and additional rate taxpayers increased from 28% to a flat 32%. This change serves as a short-term adjustment before a more comprehensive overhaul.

• From 6 April 2026, all carried interest will be classified as trading profits and taxed as income. This means it will be subject to income tax at an individual’s marginal rate and Class 4 National Insurance Contributions (NICs).

• To reflect the long-term nature of carried interest, a 72.5% multiplier will apply to “qualifying” carried interest. For additional rate taxpayers, this results in an effective tax rate of approximately 34.1%, including NICs.

What Is “Qualifying” Carried Interest?

Qualifying carried interest generally excludes what the government terms “income-based carried interest” (IBCI)—which mainly refers to carried interest from funds with an average holding period (AHP) of less than 40 months.

The government had also proposed additional conditions for qualification, focusing on ensuring the tax benefits apply only to genuine long-term incentives.

Government’s Response to Proposed Conditions

Two main conditions were considered in the Call for Evidence:

1. Minimum Co-Investment Requirement

Most respondents opposed introducing a mandatory minimum co-investment requirement at the team level. Concerns included complexity, impracticality, and the risk of reducing the UK's competitiveness compared to other jurisdictions.
The government has decided not to introduce a co-investment requirement.

2. Minimum Holding Period for Carried Interest Rights

The aim here was to ensure carried interest represents genuine long-term rewards. However, the government believes this objective is already met through existing legislation, namely:

• The AHP condition, requiring funds to hold assets for at least 40 months on average to qualify.
• Existing tax rules, including those on employment-related securities.

Therefore, no new minimum holding period condition will be introduced.

Important Technical Amendments

1. Abolition of Employment Related Securities (ERS) Exclusion

Previously, carried interest granted to employees was excluded from the AHP condition due to ERS rules. This exclusion will be removed, so the AHP condition will apply equally to employees and LLP members.
(Note: other ERS rules remain unchanged.)

2. Refinements to the AHP Condition

Several targeted amendments will address practical challenges for certain fund types:

• Removal of automatic AHP failure for direct lending funds.
• Introduction of new rules for credit funds governing debt investments.
• Simplification of rules for funds of funds and secondary funds.
• Expansion of rules to cover unwanted short-term investments such as loan syndications.

3. Payments on Account

Income tax and NICs paid on carried interest in the previous tax year will count towards payments on account for the following year. Individuals with irregular carried interest income may claim to reduce or cancel payments on account to avoid overpayment of tax.

Territorial Scope and Non-Resident Managers

The new regime will apply to non-UK resident managers for carried interest related to investment management services performed in the UK. This raises concerns about potential double taxation, as some managers’ home jurisdictions may also tax carried interest.

To mitigate this risk, the government will introduce statutory limitations:

• Services performed before 30 October 2024 (announcement date) will be treated as non-UK.
• A UK workday threshold means services performed in a tax year where the manager spends fewer than 60 UK workdays will be treated as non-UK.
• If an individual has spent three full tax years outside the UK and is below the 60 workday threshold, UK services performed thereafter will be treated as non-UK.

While not eliminating all double taxation risks, these measures aim to ease compliance for short-term UK visitors.

Next Steps and Timeline

• Draft legislation reflecting these updates will be published for technical consultation before 22 July 2025 (Parliament’s Summer Recess).
• The revised carried interest tax regime will be incorporated into the Finance Bill 2025/26.
• Implementation is scheduled for 6 April 2026.

What This Means for You

• Fund managers and in-house tax teams should prepare for a shift from capital gains to income tax treatment of carried interest starting in 2026.
• The removal of the ERS exclusion and other technical amendments to the AHP condition may impact fund structures and tax planning.
• Understanding the qualifying criteria and the territorial scope will be critical, especially for non-UK resident managers.
• Engagement with upcoming consultations and timely review of carried interest arrangements will be vital to ensure compliance and optimize tax outcomes.

Need Help Navigating These Changes?

If you’re involved in fund management or private capital tax functions and want to understand how these reforms affect your operations, now is the time to seek expert advice and review your carried interest structures.

Feel free to reach out with your questions or for assistance with tax planning in light of these reforms.