From Crackdown to Calibration: The UK’s Evolving Carried Interest Regime

Shifting Gears

In November, we covered the UK government’s proposal to overhaul the tax treatment of carried interest in the United Kingdom—an effort to close perceived loopholes by shifting carried interest fully into the income tax regime, increasing the effective tax rate and re-engineering the surrounding framework. The headline proposal was effectively a 34.1% rate for certain “qualifying” carried interest.

Through the subsequent consultation process, the industry has expressed concerns about various aspects of the reforms, including the proposal to introduce one or more additional conditions for carried interest to qualify for the reduced rate, and the UK tax “tail” for non-UK managers who perform services in the UK but receive their carry long after they’ve departed (potentially subjecting them to double taxation).

In their consultation response, the government appears to have taken on board many of these concerns and has significantly curtailed some of the more concerning elements of the proposals—taking much of the sting out of the carried interest tail and dropping both of the qualifying conditions.

The government also proposes to make certain changes to the Income Based Carried Interest (IBCI) rules (which may apply where a fund’s assets are held on average for less than 40 months) which could, in principle, see a reduction in the effective tax rate for carry holders in certain credit funds, potentially unlocking the 34.1% rate for returns currently taxed at 45% as a result of the IBCI rules.

What’s Next?

As always, the devil will be in the detail. Draft legislation is expected before Summer Recess 2025, with final provisions to follow in Finance Bill 2025–26. The government will continue to refine the detail of the regime in consultation with stakeholders via the technical working group.

The Consultation Response – In Detail

1. The Qualifying Conditions

The government had suggested two potential qualifying conditions to access the 34.1% rate—a minimum co-investment requirement and a minimum time period between award and receipt of carried interest.

The co-investment requirement was widely opposed by industry professionals. Respondents highlighted the complexity of applying a uniform rule across diverse fund structures, questioned how “team-level” thresholds would be defined and noted that co-investment is already standard practice. They also queried the conceptual distinction between carry and co-investment returns.

The proposed time-based condition was similarly opposed. The UK’s existing carried interest framework already imposes a 40-month asset-level average holding period condition under the IBCI rules in order to benefit from the favourable carry tax rate, and respondents warned that adding an individual-level test would be duplicative, burdensome, potentially distortive and reduce the UK’s competitiveness. Particular concerns were raised about the disproportionate impact on deal-by-deal carry structures, new joiners and those receiving incremental awards through the life of the fund.

The government confirmed yesterday that neither condition will be pursued. As such, provided that carried interest does not fall within the IBCI rules, it should in principle be able to benefit from the 34.1% rate.

2. Territorial Scope – A More Proportionate Approach

Under the revised proposal, carried interest will still be treated as arising from a U.K. trade where it relates to investment management services performed in the UK. This aspect of the proposal was particularly controversial, as it could expose managers to UK tax on carried interest received many years after leaving the UK where that carry relates to management services provided in the UK.

While not wavering on the policy rationale for this change, the government acknowledges the uncertainty around other jurisdictions’ treatment of the carry and the application of double tax treaties. It also appears to recognise the importance of maintaining the UK’s attractiveness as a hub for asset management, and has therefore proposed a series of limitations to soften this measure. To provide certainty to taxpayers, the government will also mandate a time-based apportionment method using UK workdays to determine the portion of carried interest attributable to UK services.

As a result, under the new regime non-UK residents will only be subject to UK tax on carried interest where it relates to services performed in the UK and all of the following apply:

• The UK services were performed in the previous three tax years;
• The UK services were performed in a tax year in which the individual is a UK tax resident or spent at least 60 workdays in the UK; and
• Where there is an applicable double tax treaty, the services are attributable to a UK permanent establishment of the relevant individual under the terms of that treaty.

The UK Government has also confirmed that UK services performed before 30 October 2024 will be treated as non-UK.

While these limitations are helpful, the government acknowledges double taxation risks may still arise—particularly where other jurisdictions treat carried interest as investment return rather than reward for management services.

3. Refining the IBCI Asset-Level Average Holding Period (AHP) Rules

The government has proposed several targeted changes to ensure the AHP rules work as intended and do not unfairly penalise certain investment strategies, with several of particular note:

• Credit Funds: A new simplified rule will apply across all credit fund types, modelled on those for other fund strategies. This change aims to make the rules more practical and better aligned with how credit funds operate commercially.
• Direct Lending Funds: The current presumption that direct lending funds fail the AHP test (unless they meet a narrow exemption) will be removed. This change acknowledges the diversity of credit strategies and is intended to ensure fairer treatment across the market.
• Funds-of-Funds and Secondary Funds: The existing separate rules for these fund types will be consolidated into a single, streamlined provision, designed to simplify the framework.
• Short-Term Investments: The exemption for disposals of unwanted short-term investments will be broadened to capture a wider range of commercial scenarios, such as loan syndications and bulk asset acquisitions by secondary funds, where such disposals are not uncommon.

In addition, the government intends to address various technical issues within the AHP rules, including the treatment of tax distributions made in anticipation of carried interest receipts.

4. Payments on Account Rules

Carried interest taxed as trading income will be included when calculating payments on account for U.K. Income Tax and Class 4 NICs. Given the irregular nature of carry receipts, this may create cash flow challenges. The government acknowledges this but does not consider it unique to carried interest and notes taxpayers can apply to reduce or cancel payments on account, where appropriate.