Carried interest taxation in the UK: reform but not abolition

• From 6 April 2026, it is proposed that carried interest will be taxed as trading income, so that fund managers receiving it will be subject to income tax and Class 4 NICs.  Provided that the carried interest meets certain qualifying conditions (see below), it will be eligible for a 72.5% multiplier, such that theeffective tax rate on such carried interest would be 34.075% for additional rate taxpayers (i.e. 72.5% of qualifying carried interest will be taxed as income, at the additional income tax rate of 45%, plus NICs at 2%).

• In the interim, from 6 April 2025 to 5 April 2026, the rate of capital gains tax payable on carried interest will increase to 32% from the current rate of 28%.

• From 6 April 2026, it is proposed that carried interest in whatever form (ie capital gain, interest, dividends) will be subject to the new income tax regime.  Therefore, the overall tax rate of carried interest which meets the qualifying conditions taking the form of interest (45% for additional rate taxpayers) and dividends (39.35% for additional rate taxpayers) will be reduced.

These changes are a long way from abolishing a separate tax regime for carried interest. Nor do they seek to increase the tax rate on carried interest to match income tax rates, as had been anticipated as a possibility.   In broad terms, the changes will mean an increase of approximately 6% in the effective tax rate on carried interest capital gains, provided that, from 6 April 2026, the conditions for carried interest to be qualifying are met.

The Government is still consulting on the detail of the qualifying conditions.  As a starting point, it has been stated that the existing ‘income-based carried interest rules’ will be applied such that, for carried interest to be qualifying, the relevant fund will need to meet the average investment holding period test in those rules.  This test generally requires the fund to have held its assets for an average period of 40 months or more.

If the average holding period is between 36 and 40 months, the carried interest is partly outside the income based carried interest rules. However, if the average holding period is less than 36 months, then 100% of the carried interest is taxed as trading income (at 45% for additional rate taxpayers). The existing exclusion from those rules for employment-related securities will be removed so that all fund managers – including those who are employees and directors – will now need to consider the income based carried interest rules.   

A consultation will run until 31 January 2025 as to the additional conditions which might be introduced.  In particular, the Government is considering the introduction of a requirement for a minimum level of co-investment (likely to be measured at a team level, rather than on an individual-by-individual basis) and a requirement for a minimum time-period between managers acquiring their rights and receiving carried interest (possibly with adjustments for new joiners).

The results of the consultation are likely to be published later this year, including the draft legislation (which will be in the next Finance Bill).

The Government does not intend to introduce transitional provisions for existing funds (other than potentially in relation to any minimum co-investment requirement), so where the additional conditions mean that fund managers do not qualify for the carried interest regime after April 2026 in respect of some funds, these measures could create an imbalance between existing funds.

Members of Hogan Lovells are involved in the working group engaging with the Government on the detail of the new carried interest regime.

Authored by Elliot Weston and Suzanne Hill.