Tax

On 5 June 2025, the UK government issued a policy update on its proposals to reform the UK tax treatment of carried interest. It has confirmed that it will:

(i) not introduce two previously proposed ‘qualifying conditions’ to be required for carried interest to qualify for a 72.5% multiplier, adjusting the amount of proceeds subject to tax under the new regime once introduced in April 2026;

(ii) introduce statutory limitations on the territorial scope of the new carried interest regime; and

(iii) make changes to the Income Based Carried Interest (“IBCI”) rules (to be renamed the Average Holding Period (or “AHP”) rules under the new regime) to assist certain categories of funds, particularly credit funds, secondary funds and funds of funds.

Background

At Autumn Budget 2024, the government announced proposals to bring carried interest within the income tax framework, with all carried interest receipts to be treated as trading profits and therefore subject to income tax and class 4 National Insurance contributions (“NICs”) with effect from April 2026. Currently carried interest returns are taxed in the UK under a source based system; in practice the returns may therefore be taxed at a blended rate of between 28% and 45% depending on the fund’s strategy. From April 2026 source will become irrelevant; carry returns will be taxed at 34.075% provided the carry is qualifying, as a result of applying a 72.5% multiplier.

The government simultaneously launched a consultation, which ran until 31 January 2025, on further conditions (in addition to existing IBCI rules) that would need to be met for carried interest to qualify for the 72.5% multiplier, specifically a: (i) minimum co-investment requirement, measured at team level; and (ii) minimum time period between a carried interest award and receipt.

No Minimum Co-Investment Condition or Holding Period

In the policy update, the government confirmed that it will not introduce these new qualifying conditions.

• Minimum co-investment requirement: The government acknowledged that this “would have a number of practical challenges, with a risk of creating unintended and/or distortive outcomes”, including on new fund managers who may lack the available capital to make co-investments into their first fund and might therefore be placed at a competitive disadvantage. The government also recognised stakeholder feedback regarding the conceptual distinction between carried interest and co-investment, and certain stakeholders’ views that its decision to move carried interest into the income tax framework weakened the case for a minimum co-investment requirement.
• Minimum holding requirement: The government acknowledged that the existing IBCI rules, which as mentioned above will be renamed the AHP condition under the new regime, combined with the employment-related securities (“ERS”) rules, are already effective in limiting qualifying carried interest treatment to long-term rewards. Incidentally, the ERS exclusion from the IBCI rules, which means that currently the IBCI rules do not need to be considered for any carried interest that is an ERS (effectively, carry awarded to employees or directors), is being removed as planned, meaning that the AHP condition will always need to be considered in relation to carried interest, regardless of whether the executive receiving the carried interest is an employee/director or not.

Territorial Scope of the Revised Regime

At Autumn Budget 2024, the government acknowledged the potentially broad territorial scope of the new regime which will subject non-UK residents to income tax and Class 4 NICs on carried interest to the extent that it relates to services performed in the UK.

While the government continues to see this as justified on the basis that any rewards for services performed in the UK should, in its view, be taxed in the UK, it has also acknowledged the practical difficulties of the scope of the new regime, including (amongst other considerations) the risk of: (i) UK taxation arising from services performed during limited business travel in the UK; and (ii) double taxation where a non-UK resident is taxed on carried interest both in their jurisdiction of residence (e.g., as investment income) and the UK (as a profit arising from a deemed trade).

With regards to double taxation, the government has confirmed its view that the treatment of carried interest as proceeds of a trade in the UK will mean that the business profits provision (typically Article 7) of the relevant double taxation agreement should apply. However, the government has also acknowledged that there may be uncertainties regarding other jurisdictions’ application of double taxation agreements, especially where carried interest returns are treated as an investment return rather than a business profit in that jurisdiction. This will need careful consideration in practice.

As a result of stakeholder concerns, the government has announced that it will introduce three statutory safeguards limiting the UK’s taxing rights for carried interest arising to non-UK residents. These safeguards will mean that any UK services performed by a non-UK resident will be treated as if they were non-UK services (and therefore the carried interest arising from such services will not be subject to UK tax) in the following circumstances:

(i) Pre-30 October 2024: if they were performed prior to 30 October 2024 (i.e., Autumn Budget 2024);

(ii) Workday threshold: if they were performed in a tax year in which the non-UK resident spends less than 60 workdays in the UK; or

(iii) Three-year tail: if three full years (in addition to the current tax year) have passed during which time the individual was neither UK tax resident nor met the UK workday threshold.

It is hoped that these safeguards should significantly limit the extra-territorial scope of UK tax on carried interest, particularly in the case of carried interest recipients: (i) who are not UK tax resident but who work a certain number of days in the UK; or (ii) who have ceased or will cease to become UK residents but continue to receive carried interest arising from historic services performed in the UK. However, again, careful consideration of these safeguards will be needed.

Changes to the IBCI Rules

As announced at Autumn Budget 2024, the government will legislate to remove the ERS exclusion from the IBCI rules. This will mean that employees (and potentially directors and other office holders) receiving carried interest under the new regime will be subject to the AHP condition.

As part of the 5 June 2025 policy update, the government has also committed to make targeted amendments to the AHP condition (i.e., what are now the IBCI rules) for certain categories of funds, in particular private credit funds, secondary funds and funds of funds. It has confirmed this position in the policy update with the following key proposals:

(i) Direct Lending Funds: Removing the “unnecessarily restrictive” rule which treats carried interest arising from direct lending funds (as defined) as automatically failing the AHP condition unless it falls within a narrow exemption;

(ii) Credit Funds: Introducing bespoke rules for all types of credit funds making the AHP condition more straightforward (this is to be achieved by, amongst other things, deeming a point of acquisition and disposal for debt investments);

(iii) Fund of Funds / Secondaries: Merging the currently separate provisions for funds of funds and secondary funds into a single simplified provision; and

(iv) Unwanted short term investments: Broadening the situations in which assets disposed of very shortly after acquisition constitute an “unwanted short term investment” so that the helpful special rules on such investments apply to a wider range of commercial scenarios (including in relation to loan syndications and bundles of assets acquired by secondary funds).

Payment on Account Rules

The government also confirmed in its policy update that the payment on account rules will apply to carried interest receipts within the income tax framework from April 2026. This means that recipients will have to calculate and pay their income tax liability by reference to what they paid the previous year. While acknowledging that carried interest receipts may be “irregular and unpredictable”, the government has justified this position on the basis that (i) other forms of trading profit are also irregular and unpredictable and (ii) there is a mechanism for taxpayers to make a claim to reduce or cancel payments on account to avoid overpayments of tax.

Next Steps

The government is continuing to consult with stakeholders and draft legislation for technical consultation is expected to be published on 21st July (“L-Day”), ahead of the legislation being introduced in the Autumn Finance Bill 2025-26.