Tax

On 30 October 2024, the Chancellor delivered the Autumn Budget which included an announcement on the highly anticipated changes to the taxation of carried interest in the UK. The scope and scale of this potential overhaul have been a topic of intense debate since the Labour Party’s 2024 General Election manifesto pledged to “close the loophole” on carried interest taxation.

Shortly after the election, the new Government published a very broad “Call for Evidence” on the tax treatment on carried interest here, reaffirming its commitment to reform in the area. The Autumn Budget speech was very light on detail on the proposed changes which, together with a summary of responses to the Call for Evidence received (see below for the key themes of those responses), were largely set out in the “Summary of Responses and Next Steps” published on the day of the Budget here.

Headline changes announced in the Autumn Budget

There are no changes to the taxation of carried interest that are effective immediately. The headline announcements are:

• UK capital gains tax (“CGT”) rate for carried interest to increase to 32% (currently 28%), effective for carry proceeds received from 6 April 2025.
• Overhaul of the UK carried interest tax regime expected from 6 April 2026 pending a technical consultation in the interim.
• No changes to the UK tax treatment of team co-investment.

Further detail below.

Between now and 5 April 2025

All of the current UK tax rules in relation to carried interest remain unchanged. This is notwithstanding the immediate increase in the rates of CGT for disposals not giving rise to carried interest announced at the Budget (an increase of 10% to 18% for basic rate taxpayers and from 20% to 24% for higher and additional rate taxpayers).

From 6 April 2025

The CGT rate for carried interest will increase to 32% from 6 April 2025 (currently 28%). This percentage increase mirrors the increase in the ordinary (non-carried interest) CGT rate applicable to higher/additional rate income tax payers as mentioned above, albeit that the latter is effective immediately. The new CGT rate for carry will apply to carry proceeds received on or after 6 April 2025. Carry paid out of proceeds other than capital gains (e.g. interest and dividends) will continue to be taxed at usual applicable income tax rates (currently 45% and 39.35% respectively).

This change is expected to remain in place until the implementation of the wider reform package expected in April 2026 (see below).

From 6 April 2026

The Government has announced an overhaul of the carried interest tax regime applicable from 6 April 2026. 

A summary of the intended regime has been published but draft legislation and further detail is awaited. It is proposed that the new regime sits alongside the existing disguised investment management fee (“DIMF”) and income based carried interest (“IBCI”) rules. The key aspects of the proposed new regime are summarised below.

• As a starting point, all carried interest would be taxed in the UK as trading profits and therefore subject to income tax (45% for additional rate taxpayers) and Class 4 national insurance contributions (2%). The capital gains tax rules for carried interest would consequently be abolished.
• “Qualifying carried interest” income would be subject to a 72.5% multiplier, in effect meaning that only 72.5% of such amounts would be subject to the income tax and NICs rates set out above. This should mean an effective income tax rate of 32.625% and an effective NICs rate of 1.45%, i.e. an aggregate effective tax rate of 34.075%, for “qualifying carried interest” from 6 April 2026 assuming no changes to the current income tax and NICs rate.
• Carried interest is expected to be qualifying carried interest if it is not IBCI; in other words and very broadly, the multiplier and therefore lower effective tax rate for “qualifying carried interest” would apply to carried interest which is currently taxed under ordinary principles depending on the nature of the underlying returns from the fund (i.e. 28% for capital and capital gains, 39.35% for dividend income and 45% for interest income). Currently, any carried interest that is taxed as IBCI (on the basis that the fund’s minimum asset holding period is not met) is already subject to 45% income tax and 2% NICs and so the basic idea is that this type of carried interest would continue to be taxed at full rates under the new regime once enacted.
• Therefore, under the proposed regime:
  • For IBCI Carried Interest: It would not qualify for the multiplier and would be subject to 45% income tax and 2% NICs in full. That is the status quo.
  • For Non-IBCI Carried Interest: It would qualify and benefit from the multiplier and an effective tax rate of 34.075%. That is an increase of 6.075% for carry paid out of capital or capital gains, but is a decrease of between 5.275% and 10.925% for carry paid out of income returns. Carry under the new regime is expected to be taxed at either 47% (IBCI) or 34.08% (non-IBCI, i.e. “qualifying carried interest”).
• The new regime is expected to apply to all individuals receiving carried interest, whether they are employees, LLP members or consultants.
• Currently the IBCI rules do not apply to carried interest that is an employment related security (“ERS”). In other words, currently employees receiving carry do not need to worry about IBCI. The length of time the fund has held its assets is therefore not relevant to the tax treatment of their carry (potentially helpful for example in the case of continuation funds). It is proposed that this exclusion for employees is abolished, and so carried interest holders who are employees would, like LLP members, also become subject to IBCI rules.
• The Government is consulting on introducing additional conditions which would need to be met for carried interest to be taxed as “qualifying carried interest” thereby benefiting from the multiplier and lower effective rate. The two proposals are:
  • a minimum co-investment condition measured at a team level (e.g. the aggregate co-investments in the fund held by carried interest holders); and
  • a minimum holding period assessed at the level of the individual (i.e. the length of time the individual waits to receive amounts of carried interest).
• The Government will consult with key stakeholders to make targeted amendments to the application of the IBCI rules to private credit funds.
• No grandfathering or transitional rules for existing structures have been proposed; the stated reason being that the Government considers the proposals do not impose new conditions or requirements which could not reasonably have been foreseen when existing funds were established.

Looking forward

The consultation process on these Autumn Budget proposals is due to close on 31 January 2025 and so nothing further is expected to be published until the consultation has concluded.

Given HMRC’s proposal to tax carry at a flat rate from 6 April 2026, depending on the detail of the final rules it is possible that there will then no longer be a need for a separate carry structure to be established for UK carry holders. Currently it is usual for a fund manager to establish a separate entity, typically a limited partnership, in which those who are awarded carried interest hold interests.

However the proposed new regime means that the UK tax rate applicable to carried interest will from 6 April 2026 no longer depend on whether the carry is paid out of capital, capital gains, interest or dividends and so flow-through treatment for UK tax purposes may no longer be relevant, subject to exactly how the Government ends up designing the new regime. If this is the case, fund structures that pay carried interest to the management team as a profit share could be significantly simpler and require fewer vehicles going forward.