On 24 July 2025, the Luxembourg government introduced Bill No. 8590 (the Bill), which proposes a new competitive carried interest tax regime with the stated objectives being: to create a legal framework that fosters the growth of alternative investment funds; to enhance the overall competitiveness of the financial sector; and to attract the 'front office' segment of the value chain, besides fund domiciliation and administration activities, to Luxembourg1.
The new carried interest regime applicable to Luxembourg resident individuals provides for:
- A reduced rate of personal income taxation of 11.45% on contractual carried interest, ie, carried interest not materialised by any participation in a fund.
- An exemption from Luxembourg personal income tax in relation to (i) carried shares and (ii) carried interest entitlement inextricably linked to direct or indirect participation in an Alternative investment Fund (AIF), subject to a 6-month holding period and percentage threshold conditions.
Scope and Carried Interest Definition
The proposed reform aims to broaden the scope of the carried interest tax regime to include all individuals working with or for the manager of an AIF who may be entitled to performance-based remuneration. This would include employees of alternative investment fund managers (AIFM) or employees of the management company of an AIF but also employees of another entity (such as an advisory company) and even non-employees such as independent board members of the AIF and partners of the management company.
The Bill defines the carried interest as the performance-based remuneration derived from the outperformance of an AIF, received based on a profit-sharing right that grants specific entitlements over the fund's net assets and income. According to the commentary to the Bill, the outperformance is the remuneration exceeding a hurdle rate (ie, an agreed minimum return) negotiated with investors. The hurdle rate must be in line with market practice and must not be set unreasonably low, otherwise the carried interest regime could be challenged based on the abuse of law theory2.
Description of the New Regime
The new regime intends to notably amend Article 99bis paragraph 1a of the Luxembourg Income Tax Law of 4 December 1967 regarding income tax (LITL) to extend the scope of carried interest arrangements covered and improve the terminology used to enhance legal certainty.
Article 99bis paragraph 1a of the LITL classifies several types of carried interests as capital gains called speculative gains, and not as employment, professional or business income. These carried interests are allocated into two subdivisions, number 1 and number 2, each subject to a specific tax treatment3:
Number 1 of Article 99bis paragraph 1a refers to the simplest form of carried interest, granted solely on a contractual basis4. The beneficiary of such contractual carried interest may, but is not required to, also hold a regular interest in the AIF, similar to that of ordinary limited partners. According to the Bill's commentary, carried interest received solely on a contractual basis is generally granted free of charge to the manager, awarded without any mandatory (direct or indirect) participation in the AIF and paid from funds that originate directly or indirectly from the AIF once the performance threshold is reached.
Contractual carried interest covered by number 1 would be taxed at a quarter of the progressive income tax rate, resulting in a marginal rate of 11.445%5.
Number 2 of Article 99bis paragraph 1a covers:
- Carried interests that are inextricably linked to a direct or indirect "ordinary" participation in the AIF; or
- Carried interests that are represented by, or materialised in,
a participation entitling the right to carried interest.
- Carried interest that is "inextricably linked to a participation" refers to carried interest granted on a contractual basis where the individual is also required to acquire a direct or indirect "ordinary" participation in the AIF. According to the commentary to the Bill, the carried interest component is usually still granted free of charge to the individual and is paid by the AIF once the performance threshold is exceeded, whereas the "ordinary" participation is acquired at a cost by the individual6. However, only the portion of income that qualifies as carried interest that is linked to outperformance benefits from the preferential tax treatment under number 2. Any other income derived from the ordinary participation is taxed under the standard regime which depends on the legal form of the AIF and the qualification of the income received.
- Carried interest represented by participation refers to carried shares, ie., a type of preferred shares, units or interest tracking a right to the outperformance of an AIF directly or through a dedicated carry vehicle, such as a special limited partnership or equivalent structure, in which the carried interest is economically structured and held.
For the purposes of number 2 of Article 99bis paragraph 1a, the transparency of an AIF will not be considered7. As such, Article 175 of the LITL will not apply, in order to prevent the disregarding of participation in a transparent AIF. In addition, without this clarification, in cases where AIFs are structured either as special or common limited partnerships (SCSp or SCS) covered by Article 175 of the LITL or as mutual funds (fonds commun de placement or FCP), the carried interest under (ii) would have to be taxed according to the nature of the underlying investments.
Carried interests under number 2 will not be taxed if the participation (ie, the ordinary shares/interests under (i) or carried shares/interests under (ii)) is realised after a holding period of more than six months and such participation represents 10% or less of the AIF's capital8, which is usually the case for carried shares.
However, if the participation is realised after a six month holding period and this represents more than 10% of the AIF's capital, the carried interest under number 2 will be taxed at half the progressive income tax rate, resulting in a marginal rate of 22.89%.
If the participation is realised within 6 months, carried interests under number 2 will be taxed at the regular progressive tax rate resulting in a marginal rate of 45.78%.
Finally, in all cases, carried interest qualifying as speculative gains will not be considered professional income and will therefore not be subject to Luxembourg social security contributions.
Next Steps
The Bill is to be further examined, and potentially amended, by the Luxembourg parliament. Should the Bill be adopted, it is expected to enter into force in 2026.
Footnotes
1. https://wdocs-pub.chd.lu/docs/Dossiers_parlementaires/8590/20250724_Depot.pdf.
2. In practice, once the invested capital has been repaid to the fund's investors, a minimum hurdle rate of 8% per year has been reached, the fund's additional profits are shared between the investors and the holders of carried interest rights, who typically receive 20% of the profits realized above that threshold. These percentages may vary but should approximate these standards.
3. Speculative gains are a sub-category of miscellaneous net income which is an income category including certain types of capital gains described in Articles 99bis to 101 of the LITL on properties, goods and substantial shareholding in a Luxembourg corporate vehicle. Speculative gains are in principle to be aggregated with the taxpayer's other income and taxed in accordance with the rates applicable to direct taxes at the progressive income tax rate (marginal rate of 45.78%).
4. i.e. carried interests that are neither linked to an investment in the AIF nor represented by a participation.
5. As a result of an amendment to Article 132 of the LITL concerning extraordinary income, carried interests listed under number 1 of Article 99bis paragraph 1a would be classified as extraordinary income.
6. The subscription or acquisition price should be at market value to avoid the risk that a free or below value acquisition could be a benefit in kind, taxable as salary income and subject to social security contributions.
7. The tax transparency of the AIF is irrelevant for the contractual carried interest of number 1 of of Article 99bis paragraph 1a.
8. As provided by Article 100(2) of the LITL.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
