In the lead up to the Autumn Budget, there was a lot of speculation about the possible changes to the treatment of carried interest. As expected, further changes were announced by the Government at the end of October.
We outline the main changes, and how managers can plan ahead of April 2026. The changes from 2026 will change the nature of carried interest so it will all be taxed as trading income and subject to income tax.
The main changes announced
From 6 April 2025 the Capital Gains Tax rate for carried interest will rise to 32%. More substantial changes will be introduced from 6 April 2026, some of the detail of which is still subject to consultation. We are expecting further details and draft legislation in 2025.
We now know that from 2026 all carried interest will be taxed as trading income, meaning that the carried interest will be subject to both Income tax and National Insurance, so taxed at an effective rate of up to 47% (45% Income Tax for an additional rate taxpayer and 2% National Insurance). This treatment will apply to all carried interest received, irrespective of whether it is capital in nature, interest or a dividend. This will be a simplification of the existing regime.
As the income is trading income, the income will be treated as UK source to the extent that investment management services, by virtue of which the carried interest arose, were performed in the UK, and outside the UK to the extent that investment management services were performed outside the UK. As such, non-resident individuals will be subject to Income Tax on carried interest to the extent that it relates to services performed in the UK, subject to the terms of any applicable double tax agreement. This approach will mirror the current treatment under the Disguised Investment Management Fee rules (DIMF).
For “qualifying” carried interest there will be a multiplier of 72.5% which will reduce the effective rate to 34%. Given this rate will apply to all carried interest, this will potentially be a reduction of the rate for people who are receiving carry predominately as interest or dividends.
To be considered “qualifying” carried interest there will be a modified version of the existing income-based carry rules (the 40 month holding period requirement). The current exclusion from the income-based carry rules for carry that is within the Employment Related Securities (ERS) regime will be abolished. This means that the test will apply equally to self-employed and employed managers.
The test will also include two new additional conditions, which are subject to further consultation:
- A minimum co-investment commitment
There will be a new requirement that there is a minimum co-investment by the managers into the fund. Whilst this is still subject to ongoing consultation, it is being suggested that is will be assessed on a collective, rather than an individual basis.
- A minimum holding period between the award of the right to receive carried interest and the receipt of the carried interest
This will be a requirement that the individual will have a minimum time period between being awarded the right to receive the carried interest and the date the carried interest is paid. This can be distinguished from the current income-based carry rules which are assessed at the fund level.
This test will apply to all carried interest arising after April 2026; there will be no grandfathering of existing arrangements.
What can managers do to plan for the changes?
Options include leaving the UK for a jurisdiction with a lower tax rate, for example Spain taxes carried interest at 22.8%. However, some jurisdictions wouldn’t tax it at all – such as Jersey if you wanted to stay close to the UK. Dubai has become a popular destination for people leaving the UK in recent years.
It would also be possible to take advantage of the non-domicile regime being introduced in countries such as Italy, which in the payment of a lump sum would take foreign carry outside of tax and is available for up to 15 years.
However, this may not be practical for many people, so there may be other restructuring options available. This may involve looking at selling portfolio companies to a follower fund, restructuring or selling companies by April 2025. There may need to be steps taken to ensure that the carried interest will be “qualifying”.
If you are affected by these changes and would like to discuss the impact on you please contact Stephen Kenny.
