On 30 October 2024, the new Chancellor Rachel Reeves announced a two-step reform to the tax treatment of carried interest in the UK. In summary, the key takeaways are as follows:

Two-Step Reform

  • From 6 April 2025: The tax rate on carried interest qualifying for capital gains treatment will increase to 32 percent. Apart from this, all other rules will stay the same while the government continues to consult on further changes to take effect in April 2026.
  • From 6 April 2026: All carried interest will be taxed as deemed trading income with no grandfathering for existing carried interest arrangements. However, “qualifying carried interest” will be taxed at an effective rate of approximately 34 percent, while non-qualifying carried interest will be taxed at up to 47 percent (including NICs). Draft legislation is expected in 2025. For reasons set out below, the proposed changes may ultimately lower the effective rate of tax on carried interest arising from credit strategies.

What is “Qualifying Carried Interest”?

  • Carried Interest will be qualifying where it meets a modified version of the existing income-based carried interest (IBCI) rules.
  • One significant change is that the IBCI rules will be amended to remove the employment-related security (ERS) exclusion from the 40-month average holding period test. Accordingly, the IBCI rules will apply on an equal basis to self-employed investment managers (i.e., members of LLPs) and employed investment managers. While this could adversely impact credit fund managers holding carried interest as an employee, the government will consult with industry bodies to make it easier for credit funds to meet the 40-month test to enable credit funds to continue to enjoy more favourable rates of tax on carried interest returns.
  • Two new conditions to the IBCI rules are under current consultation:
    1. A minimum co-investment commitment requirement similar to France and Italy is being contemplated. The government has indicated that any co-investment condition would likely be assessed on a collective basis on the management team as a whole rather than at an individual level to mitigate the impact on junior managers.
    2. A minimum holding period requirement between the award of carried interest to an individual and the receipt of the carried interest. The consultation indicates that this could be a period of 5-7 years, but this was in the context of private equity investment strategies and it is unclear at this stage whether different holding periods for different fund strategies will be introduced.
  • Stakeholder comments on these two new conditions need to be submitted to HMRC by 31 January 2025.

Simplification of Tax Regime

  • The new trading income tax charge applicable to carried interest will be an exclusive tax charge, which will eliminate the need to assess the underlying nature of carried interest when received (capital gain, dividend, interest). Provided the new IBCI rules can be satisfied, this change could simplify downstream fund structuring, and could reduce the effective tax rate for carried interest largely comprised of interest income to 34 percent as opposed to up to 45 percent in the case of interest income under the current regime.

For further discussion on how these changes may affect you or your existing arrangements, please contact a member of Dechert's Global Tax team.