Carried interest tax reform - how it will work
Carried interest tax reform - how it will work
The changes to the taxation of carried interest announced in the 2024 Autumn Budget are significant, impacting the environment in which asset managers operate and their reward structures. With legislation expected to be released in 2025, there is uncertainty for asset managers setting up and operating carried interest structures in the interim.
While many are adopting a wait-and-see approach, it is always helpful to look forward. This article focuses on key practical considerations for asset managers in light of the changes announced so far.
In the Autumn Budget, it was announced that the carried interest capital gains tax rate will increase from 28% to 32% in 2025/26. From 2026/27, a new carried interest regime will apply, treating all carried interest as trading profits subject to income tax (up to 45%) and Class 4 NICs (up to 2%). The amount of ‘qualifying’ carried interest subject to these taxes will be adjusted by applying a 72.5% multiplier, resulting in an effective tax rate of 34.075%.
Carried interest will be qualifying if it is not Income Based Carried Interest (IBCI), i.e., from funds with an average investment holding period of 40 months or more (with tapering starting at 36 months). Employees will no longer be excluded from the IBCI rules, a significant change as this exclusion was widely applied.
Specific rules will impact non-resident individuals receiving carried interest for services performed in the UK and those in the new Foreign Income and Gains (FIG) regime, replacing the non-domiciled regime in April 2025. Double tax treaty relief will be important for these individuals.
The new regime is still being developed - as part of a consultation running until the end of January, the government is considering further conditions for carried interest to be qualifying, such as a minimum co-investment requirement and/or a minimum time period between a carried interest award and receipt.
In light of the upcoming changes and inherent uncertainty, asset managers should take proactive steps to navigate the evolving landscape. Below are practical considerations and actions to address the potential impact of the new rules:
Timing of crystallisation: With three different sets of rules to consider before 6 April 2026, the timing of crystallisation events will be critical. Review your pipeline of exits and understand the implications for carried interest holders.
Investment holding periods: Both current and new funds should review investment holding periods to determine whether the IBCI rules apply to employees and self-employed fund executives. Implement procedures for monitoring and documenting these periods to ensure compliance.
Proposed qualifying conditions: Consider the implications of potential minimum co-investment commitments and personal holding periods for carried interest. While awaiting more details, explore options to build flexibility into carry awards and co-investment funding for new structures.
Globally mobile individuals: Assess the impact on globally mobile individuals, including access to double tax treaty reliefs and the new Foreign Income and Gains (FIG) regime. For non-domiciled individuals claiming the remittance basis up to April 2025, consider options like the Temporary Repatriation Facility and capital gains tax rebasing for foreign asset disposals from 6 April 2025. Additionally, ensure individuals becoming non-UK residents are aware of potential tax liabilities under the new carry regime.
Operational implications: Use this as an opportunity to evaluate fund manager reward strategies, ensuring reward strategies align with investor expectations. While carried interest remains a key incentive, alternatives such as profit shares, growth shares, and bonus arrangements could simplify administration and maintain competitiveness.
Wider reward strategy: Asset managers can take this as an opportunity to consider the future of fund manager rewards. Carried interest is one way to reward fund executives, but other options such as profit shares, growth shares, and bonus arrangements (which can be simpler to administer) could also be effective. The competitiveness of reward strategies and their impact on investor relationships should be evaluated.
Fund structures: Asset managers should carefully evaluate their existing carried interest structure in conjunction with the overall fund and deal structuring, as historical approaches may no longer be effective under the new rules.
By addressing these areas now, heads of tax and finance teams can better position their organisations to adapt to the changes ahead, while also ensuring compliance, operational efficiency, and alignment with long-term business goals.
When thinking through the business impact of the changes, in advance of the final rules being published, heads of tax and finance teams can prepare by:
Our team works collaboratively across various specialisms, including partnership tax, corporation tax, personal tax, VAT, and transfer pricing, and across multiple jurisdictions. We can help you plan for the upcoming changes by assessing the impact on you, your team and your investment structures. If you would like to discuss this or your structures more generally, please feel free to get in touch with Jennifer Wall or your usual point of contact at BDO.
While many are adopting a wait-and-see approach, it is always helpful to look forward. This article focuses on key practical considerations for asset managers in light of the changes announced so far.
Changes to the Taxation of Carried Interest
In the Autumn Budget, it was announced that the carried interest capital gains tax rate will increase from 28% to 32% in 2025/26. From 2026/27, a new carried interest regime will apply, treating all carried interest as trading profits subject to income tax (up to 45%) and Class 4 NICs (up to 2%). The amount of ‘qualifying’ carried interest subject to these taxes will be adjusted by applying a 72.5% multiplier, resulting in an effective tax rate of 34.075%. Carried interest will be qualifying if it is not Income Based Carried Interest (IBCI), i.e., from funds with an average investment holding period of 40 months or more (with tapering starting at 36 months). Employees will no longer be excluded from the IBCI rules, a significant change as this exclusion was widely applied.
Specific rules will impact non-resident individuals receiving carried interest for services performed in the UK and those in the new Foreign Income and Gains (FIG) regime, replacing the non-domiciled regime in April 2025. Double tax treaty relief will be important for these individuals.
The new regime is still being developed - as part of a consultation running until the end of January, the government is considering further conditions for carried interest to be qualifying, such as a minimum co-investment requirement and/or a minimum time period between a carried interest award and receipt.
Next steps for asset managers
In light of the upcoming changes and inherent uncertainty, asset managers should take proactive steps to navigate the evolving landscape. Below are practical considerations and actions to address the potential impact of the new rules: Timing of crystallisation: With three different sets of rules to consider before 6 April 2026, the timing of crystallisation events will be critical. Review your pipeline of exits and understand the implications for carried interest holders.
Investment holding periods: Both current and new funds should review investment holding periods to determine whether the IBCI rules apply to employees and self-employed fund executives. Implement procedures for monitoring and documenting these periods to ensure compliance.
Proposed qualifying conditions: Consider the implications of potential minimum co-investment commitments and personal holding periods for carried interest. While awaiting more details, explore options to build flexibility into carry awards and co-investment funding for new structures.
Globally mobile individuals: Assess the impact on globally mobile individuals, including access to double tax treaty reliefs and the new Foreign Income and Gains (FIG) regime. For non-domiciled individuals claiming the remittance basis up to April 2025, consider options like the Temporary Repatriation Facility and capital gains tax rebasing for foreign asset disposals from 6 April 2025. Additionally, ensure individuals becoming non-UK residents are aware of potential tax liabilities under the new carry regime.
Operational implications: Use this as an opportunity to evaluate fund manager reward strategies, ensuring reward strategies align with investor expectations. While carried interest remains a key incentive, alternatives such as profit shares, growth shares, and bonus arrangements could simplify administration and maintain competitiveness.
Wider reward strategy: Asset managers can take this as an opportunity to consider the future of fund manager rewards. Carried interest is one way to reward fund executives, but other options such as profit shares, growth shares, and bonus arrangements (which can be simpler to administer) could also be effective. The competitiveness of reward strategies and their impact on investor relationships should be evaluated.
Fund structures: Asset managers should carefully evaluate their existing carried interest structure in conjunction with the overall fund and deal structuring, as historical approaches may no longer be effective under the new rules.
By addressing these areas now, heads of tax and finance teams can better position their organisations to adapt to the changes ahead, while also ensuring compliance, operational efficiency, and alignment with long-term business goals.
What to do next
When thinking through the business impact of the changes, in advance of the final rules being published, heads of tax and finance teams can prepare by:
- Looking ahead to future exits and understanding how they will impact the carried interest holders
- Implementing procedures for monitoring and documenting investment holding periods for IBCI purposes
- Looking at the position for key globally mobile individuals, and thinking about future inbound individuals and the tax landscape for them when coming to the UK (and whether this can be made more attractive)
- Stepping back and thinking about reward options aside from carried interest, such as profit shares and growth shares
- Thinking about carried interest structuring alongside fund and deal structuring – old structures may no longer be effective.