Carried interest and UK tax – changes are coming

This article summarises the Government’s policy update on how the revised carried interest tax regime announced at Autumn Budget 2024 will operate.

Following consultation with fund industry stakeholders, the Government has published a policy update which gives some clarity on how the revised carried interest tax regime announced at Autumn Budget 2024 will operate.

Before analysing the update, lets first recap the current position.

What is carried interest and why is it controversial?

• Carried interest is a share of profits from, for example, a private equity or venture capital fund paid as a return to individual fund managers. It is often the largest return fund managers will receive from their involvement with the fund, typically the ‘pot’ of carried interest to be shared amongst fund managers will amount to c20% of a fund’s returns, usually arising from a sale of underlying assets.
• Carried interest typically is only paid if a fund achieves a specified minimum return.
• Historically, carried interest was considered a return on investment and taxed as a capital gain rather than ordinary income, usually at a lower rate. However, as carried interest could also be seen as a performance related reward to fund managers for the work they perform for the fund the Government announced at Autumn Budget 2024 that carried interest would instead be brought within the income tax rules.
• As a transitional measure in the UK, from 6 April 2025, the capital gains tax rate applying to carried interest increased to 32% (from 28% previously) and from 6 April 2026, a revised tax regime for carried interest will be introduced and all carried interest will instead be taxed within the Income Tax and Class 4 NICs framework with a 72.5% multiplier applied to  ‘qualifying carried interest’, reducing the taxable amount and giving an effective tax rate of 34.075%.

What is happening now?

Ahead of draft legislation, which will apply to employee and self-employed fund managers, being published in July 2025, the Government has published a response to the consultation on the taxation or carried interest which addresses certain matters that were causing anxiety in the fund management world.

What are the key points?

• Additional conditions, regarding a minimum co-investment or minimum holding period before carried interest is realised which were proposed in Autumn Budget 2024, will not be introduced. If the carried interest is not income-based carried interest (which, very broadly, should be the case if the fund’s holding period for its underlying assets exceeds 40 months (the ‘average holding period condition’)), it should fall within the new carried interest regime.
• The exclusion for employment related securities from the average holding period condition will be removed aligning the treatment of carried interest held be employees and with non-employees.
• The income based carried interest rules will be amended so that they operate more effectively for credit funds and funds of funds
• Non-UK residents will only be subject to Income Tax on carried interest to the extent that services were performed in the UK and certain conditions apply, including that the services were performed in a tax year in which the manager was a UK tax resident or worked in the UK for 60 days or more.

What does this mean?

The fund management industry is expected to welcome the policy update, which seems to have broadly acted on concerns raised by the funds industry and brings a degree of certainly in respect of the topic in generally uncertain times.

It helps identify what falls within the regime and by dropping the minimum co-investment requirement and the minimum hold period requirement, layers of complexity have been removed and concerns over how such conditions would detract from the UK’s suitability as an asset management hub have been allayed.

Another move that will be welcomed is in relation to the UK tax position of UK non-residents. Under the original proposals, they would, broadly and subject to any relief under a double tax treaty, potentially be liable to the extent they received carried interest relating to services performed in the UK regardless of how little time they spent in the UK and when the carried interest arose. This had the potential to, again, lessen the attraction of the UK for fund managers. There will now be statutory limitations on the territorial scope of the new legislation, including for services provided in the UK to be treated as non-UK services if three full tax years have passed, in which period the individual is non-UK resident and has spent less than 60 working days in the UK in those tax years. 

What’s next?

The draft legislation will be published prior to Parliament’s Summer Recess which starts on 22 July 2025 and the final text of the legislation will form part of next Finance Bill in 2026.

If you would like to discuss any of the points raised in this article, please contact Jonathan Cantor.