Carried interest reform: A focus on territorial scope

In this article, we bring internationally-mobile fund executives up-to-speed on the proposed reforms to the UK’s taxation of carried interest. We focus on the territorial scope of the new regime and the impact the reforms could have on carry-holders’ future relocation plans and remuneration structuring.

Introduction

The Government’s proposals to reform the taxation of carried interest in the UK are now as clear as they have ever been, with the publication of draft legislation on Legislation Day 2025 to implement the policy changes first announced in the Autumn Budget 2024. Please see our previous article here for a summary of the proposed reforms following the Government’s June 2025 consultation response. 

Carry-holders will no doubt focus on the increase to the headline tax rate (to 34.1%, from 32% this tax year and 28% before that), but just as – and arguably more – important are the structural changes to bring the carry regime within income tax principles for the first time. These will have especially important implications for territorial scope – that is, the extent to which the UK will tax carry arising to an individual with international connections.

We assume in this article that the new regime will be implemented in line with the latest draft legislation, but it is important to note that the Government is still consulting on technical aspects of the reforms and there is still opportunity for amendments before the rules come into force.

Headline points

• From 6 April 2026 carried interest will be taxed as a form of trading income in the UK, as opposed to a capital gain.
• That trading income will be subject to income tax and national insurance contributions and the effective rate of tax for many will be just over 34%.
• UK tax residents will generally be subject to UK tax on all carried interest they receive, unless they qualify for the new FIG regime (see our high level summary on this). Double tax treaties may also assist although how those will apply in practice is currently unclear.
• Non-UK residents (and UK residents who benefit from the FIG regime) will be subject to UK tax on carried interest to the extent they have performed investment management services in the UK during the lifetime of the relevant fund. This is regardless of whether those services relate to the fund which is actually generating the carry in question.
• However, there are also a number of rules which disregard work performed in the UK in various scenarios. These will materially reduce the UK tax exposure of many non-UK tax residents in particular.
• The effect of the UK’s temporary non-residence rules on carried interest will also change. Carried interest arising from 6 April 2026 onwards will no longer be in the scope of those rules.

Current rules

Carried interest has, until now, generally fallen to be taxed in line with the underlying returns which form the carried interest and as such any chargeable gains have been within the capital gains tax regime. There are exceptions to this, most notably for “income-based carried interest” (“IBCI” – which, broadly, arises from funds whose assets do not satisfy minimum average holding periods).

From a territorial perspective, as a general rule:

• UK tax residents are subject to capital gains tax on chargeable gains realised on disposals of their worldwide assets; but
• non-UK tax residents are only subject to capital gains tax on chargeable gains arising on disposals of certain UK-situated assets – most notably, interests in UK land or land-rich entities.

Carried interest gains are chargeable gains, but subject to specific rules for their calculation. This means that, until now, carried interest gains arising to a UK resident have generally been within the scope of UK tax whether they relate to investment management services provided by the relevant carry recipient in the UK or elsewhere. By contrast, a non-UK resident carry recipient has generally been outside the scope of UK tax even if some, or all, of the investment management services to which their carry entitlement relates were performed in the UK. It was only if a carry recipient was a remittance basis user that the location of their services became a key consideration.

Another consequence of being taxed as chargeable gains has been that carried interest is within the scope of the “temporary non-residence” (TNR) rules. Broadly, the TNR rules ensure that individuals who become non-UK resident for only a brief period of time cannot dispose of assets in that period without paying UK tax. Generally speaking, gains realised (and certain forms of income received) during a period of non-UK residence which lasts 5 tax years or less, will be taxed in the year of return to the UK.

It is always important to remember the impact that double taxation agreements can have to override the general principles of territoriality under UK law, including those set out above. Furthermore, the current rules for calculating a carried interest gain chargeable to capital gains tax technically permit an adjustment to the amount chargeable to take into account tax already suffered in respect of the carry. This could, in principle, include foreign tax suffered in respect of the relevant amount (for example, US tax on a UK tax-resident US citizen in receipt of dividend income that also qualifies as carried interest) – although HMRC generally takes the position that only UK taxes can be adjusted for under this provision.

New rules

From 6 April 2026, carried interest will be taxed within the income tax framework instead. Carried interest will be treated as profits of a trade, chargeable to income tax at the taxpayer’s marginal rate and subject to Class 4 national insurance contributions (“NICs”).

Where the carry is “qualifying” (which will generally include any carry which is not subject to the IBCI rules), a multiplier of 72.5% will be applied to the amount of the “qualifying profits” (qualifying carry less permitted deductions) when determining total profits subject to income tax.

An individual in receipt of fully qualifying carry should be able to benefit from an effective tax rate of c. 34.1% on their carry – still higher than the current 32%, but much less than the 45% (plus NICs) marginal rate suffered on other forms of income.

From a territorial perspective, the shift from the capital gains tax world to income tax principles is fundamental:

• as with chargeable gains, a UK resident is generally subject to income tax on their worldwide trading profits (subject to relief under double taxation arrangements);
• unlike for chargeable gains, however, a non-resident individual’s liability for UK income tax on trading profits depends largely on whether they are trading in the UK.

Because of this, the UK tax treatment of carry will no longer be determined solely by where the carry recipient is tax resident when the carry is paid and may instead depend on where they performed the investment management services from which the carry arose.

This reflects the Government’s position that carried interest is, fundamentally, a reward for the performance of investment management services, and so it wants the UK to tax that reward to the extent those services are performed in the UK, regardless of the tax residence of the carry-recipient.

However, the Government has also recognised that simply applying the default territorial principles for trading income could give rise to issues of double taxation where other jurisdictions continue to see carry more like an investment return. In such circumstances, it could be unclear whether relief under applicable double tax treaties would be available to prevent the carry-holder from suffering tax in both the UK (where they would be treated as receiving trading profits from a UK trade) and in another country (where they might be treated as in receipt of an investment return).

Partly to mitigate this, and partly to provide increased clarity generally, the new rules will contain specific provisions governing the territorial scope of the charge to income tax on carry profits.

Time-based apportionment

The new rules provide a framework for determining whether the carry-holder’s deemed trade is carried on wholly in the UK, wholly outside the UK or partly inside, partly outside. Determining this is particularly important for non-UK residents and those eligible for the new FIG regime (i.e. those in their first four tax years of UK residence).

The framework hangs on an apportionment of the individual’s “applicable workdays” between UK workdays and non-UK workdays.

For these purposes, an “applicable workday” is a day:

• on which the individual performs any investment management services (and those services do not need to be for the scheme in connection with which the individual is receiving carry)
• in the period between (roughly) acquiring the carry and the relevant carry entitlement arising.

A “UK workday” is an applicable workday on which the individual spends more than three hours performing those investment management services in the UK. Investment management services performed while travelling to or from the UK are not counted towards an individual’s three hours per day.

A day on which the individual works in the UK but does 3 hours or fewer of work will effectively count as a non-UK workday for these purposes.

Where all applicable workdays are UK workdays, the trade is wholly carried on in the UK. Likewise, where there are no UK workdays, the trade is wholly outside the UK and not within the scope of UK income tax. But where there is a mix of UK workdays and non-UK workdays, to determine the profits within the scope of UK tax, an apportionment of both the individual’s qualifying and non-qualifying profits is made by reference to the proportion of applicable workdays that are UK workdays (subject to the “guardrails” discussed below).

This “simple” time-based apportionment method should make it much easier to determine the extent of an individual’s UK taxable base. But this welcomed clarity should not distract from the overall effect of the new regime, which will be to bring non-UK tax residents within the scope of UK tax on their carry in the future where previously they would not have been. There are also the practical difficulties of accurately recording all workdays and their location, particularly for the internationally mobile.

Statutory “guardrails”

Without more, under the rules above, an individual who provides investment management services for more than three hours on just one day in the UK could have a UK tax liability when they ultimately receive their carry. For existing carry arrangements, there would also be significant issues in trying to establish a carry-holder’s historic UK workdays, given that tracking them had never previously been a requirement.

Recognising these issues, the Government has proposed certain exceptions to the general rules described above. Consequently, the following UK workdays will effectively count as non-UK workdays instead:

• UK workdays prior to 30 October 2024 (Budget Day) (“Budget Day Guardrail”);
• UK workdays in a “non-UK tax year” (“60-day Guardrail”); and
• UK workdays prior to a period of three or more non-UK tax years (“Three-year Guardrail”).

The first bullet is an important transitional saving provision. The second and third hang on the definition of a “non-UK tax year” – which will be a tax year for which the individual both (i) is not UK tax resident, and (ii) has fewer than 60 UK workdays. In all cases, however, those days remain “applicable workdays” and so can be used to increase the denominator of the apportionment fraction and reduce the proportion of carry within the scope of UK income tax.

Taken together, this means that:

• Non-UK residents, and UK residents eligible for the FIG regime, can treat all of their applicable workdays prior to 30 October 2024 as non-UK workdays. They should keep track of such days because they can potentially be used to reduce UK tax exposure on future carried interest;
• non-resident carry-holders will need to keep their UK workdays below 60 per tax year for each tax year in which they are non-resident to ensure that such days are not counted as UK workdays when determining their UK tax liability on their carry; and
• non-resident carry-holders who have been outside the UK for at least three consecutive tax years (and kept their UK workdays below 60 each year) can effectively wipe their UK carry workday slate clean: all their UK workdays prior to such three-year period will become non-UK workdays and so help to reduce the carry-holder’s future tax liability even if they incur further UK workdays in future.

A carry-holder looking to leave the UK can think of themselves as having a three-year “tail” of UK tax exposure on their carry, so long as they comply with the 60-Day Guardrail in each year of non-residence.

It should be noted that any UK workdays disregarded by the guardrails should still be tracked. Although they will not give rise to UK tax exposure, they still class as “applicable workdays” when apportioning carried interest and so can actually serve to reduce UK tax on carry received in the future.

For example, if a non-resident executive had the following workday profile:

Tax year	UK workdays	Non-UK workdays
2024/25 (All workdays incurred after carry arrangements are implemented)	250  (125 pre-30 October 2024 and 125 post-30 October 2024)	0
2025/26	50	150
2026/27	50	150
2027/28	50	150
2028/29 (All workdays incurred before realisation of carry)	100	50
Total	500	500

and realised carried interest profits in the 2029/30 tax year, then:

• absent the guardrails, 50% (500 / 1000) of such carried interest would be taxable in the UK due to the executive’s UK workdays;
• because of the transitional rules:
  
  
  • the 125 UK workdays pre-30 October 2024 are treated as non-UK workdays thanks to the Budget Day Guardrail;
  • the 125 UK workdays post-30 October 2024 in the 2024/25 tax year are treated as non-UK workdays because they occurred prior to a period of three consecutive years (2025/26 to 2027/28 inclusive) in which the executive was non-UK resident and had fewer than 60 UK workdays – i.e. thanks to the Three-year Guardrail;
  • the 150 UK workdays across the 2025/26 to 2027/28 tax years are also treated as non-UK workdays thanks to the 60-day Guardrail applying each year;

• if all those UK workdays were then ignored completely from the calculation, the executive would have 100 UK workdays and 500 non-UK workdays, subjecting just under 17% (100 / 600) of their carried interest profits to UK tax;
• but because the UK workdays between 2024/25 and 2027/28 that are treated as non-UK workdays still count as “applicable workdays”, the executive is actually treated as having 100 UK workdays and 900 non-UK workdays – leaving only 10% (100 / 1000) of their carried interest exposed to UK tax.

Whether reviewing historic day counts is an exercise worth undertaking now, or only shortly before carry is expected to arise, will likely depend on how certain the individual is that they will incur (or have already incurred) UK workdays prior to their carry materialising. For those acquiring carry rights from now on, it would be prudent to keep track of their UK workdays as they go along and to maximise the three-hour rule (and travel exception) to manage their potential future tax liabilities as best they can.

FIG regime

The analysis above focuses on non-UK tax resident recipients of carry. But the new rules will also be relevant to UK tax residents looking to benefit from the UK’s new four-year FIG regime. Broadly, this regime permits an individual who has previously been non-UK tax resident for at least ten consecutive tax years to claim a 0% rate of tax on foreign income and gains arising during their first four years of UK tax residence.

Carried interest arising in this period will generally be treated as non-UK source income, and so be eligible for the 0% rate, to the extent it is attributed to non-UK workdays under the rules described above.

The apportionment principles are therefore fundamental for determining the extent to which a new UK tax resident executive could claim FIG relief in relation to any carry they may realise in their first four years of UK tax residence. 

Other points to note

These rules do not replace double taxation agreements – so it will still be possible to obtain relief from double tax under those in certain circumstances. It does, however, appear that the Government is formally removing the possibility of making adjustments to the taxable amount to take into account foreign tax suffered in respect of the same carry (though adjustments will still be possible if UK income tax has already actually been paid in respect of the carry, or if another person has paid UK tax in respect of it). Whilst this is consistent with HMRC’s current practice, it makes it even more important to ensure, so far as possible, that relief under double taxation arrangements can be obtained if the carry-holder is chargeable in both the UK and another jurisdiction in respect of the same carry. 

The changes also impact the interaction of carry with the TNR rules described earlier. As mentioned, whilst the TNR rules apply to most gains, they only apply to limited types of income. Based on the current draft legislation, carry received on or after 6 April 2026 will be treated as a form of deemed income which will not be within the scope of the TNR rules. In other words, carry-holders who leave the UK temporarily and receive carry while non-resident should not need to worry about that deemed income being brought back into the UK tax net under TNR principles in their year of return.

However, care must still be taken until 5 April 2026 as carried interest capital gains arising in the 2025/26 tax year or earlier will remain within scope for the TNR regime (potentially being taxed as trading income when the individual returns to the UK). There are also some further complexities in the way that TNR principles have been assimilated to the new carry regime in the draft legislation, which makes it important for executives planning to return to the UK after only short periods abroad to seek advice on these issues.

Summary

Territorial scope is only one of many areas affected by the reforms to the taxation of carried interest – but it is a particularly important one for executives currently contemplating the attractiveness of the UK’s fund management industry. Both existing and prospective carry-holders with international connections should seek advice on their arrangements to establish how they will be taxed under the new regime and what opportunities there may be to optimise their positions. We can help with that and with many other tax and estate planning issues for individuals in the asset management industry. Please do reach out to us for further information.