On 5 June 2025, HM Treasury released its response and policy
update to the carried interest consultation which was launched in
the October 2024 Budget ("2024 Budget
Consultation") and which ended on 31 January 2025 in
relation to the new rules to come into effect on 6 April
2026.
In overview, the latest updates to the government's thinking on
the taxation of carried interest are largely positive, especially
(1) the decision not to include proposed additional qualifying
carried interest conditions such as holding period or co-investment
requirement outlined in the 2024 Budget Consultation, (2) the
proposed simplification to the 40-month average holding period test
as it applies to direct lending credit funds and secondary/fund of
funds and (3) clarifications to the UK territorial scope of
qualifying carried interest taxation to recipients that are non-UK
tax resident.
Qualifying versus Non-Qualifying Carried Interest – The Conditions
In summary, with effect from 6 April 2026 it is proposed that all carried interest receipts (whether of a capital or income nature) will be taxable as deemed trading income under a new income tax regime with no grandfathering for existing carried interest arrangements. However, where carried interest meets a modified form of the 40-month average holding period set out in the current income based carried interest rules (now called the asset-level average holding period condition or the "AHP Condition") the carried interest will be "qualifying carried interest" subject to a bespoke discounted rate of income tax and class 4 NICs at an effective combined rate of approximately 34% for additional rate taxpayers. Carried interest that fails to satisfy the AHP Condition (non-qualifying carried interest) will be taxable at full marginal income tax rates and national insurance at a maximum rate of 45% income tax plus 2% NICs.
In the 2024 Budget Consultation, the government indicated that it was considering the introduction of two new conditions for carried interest to qualify for the lower rates of tax:
- a minimum co-investment requirement, measured at team level
- a minimum holding period condition for individuals.
It has now been confirmed that neither of these conditions will be taken forward so that the only condition which needs to be considered to ascertain if carried interest is qualifying is the AHP Condition.
Reforms to the AHP Condition – Credit Funds
In the 2024 Budget Consultation, the government recognised that
amendments to the 40-month average holding period test (now the AHP
Condition) were needed in order to improve the without undermining
its core purpose of ensuring that qualifying carried interest
treatment only applies to long-term investment strategies. The
government has now provided further details regarding these
proposed changes, which are particularly welcome for credit
funds.
In summary, the direct lending fund rules will be abolished so that
all credit funds can now automatically fall within the average
holding period rules set out in the AHP Condition. These rules will
be replaced with a new bespoke provision for all types of credit
funds (direct lending or secondary loans etc.) which aim to make
the rules more straightforward by deeming when debt investments are
made and disposed of.
UK Territorial Scope
A consequence of deeming carried interest receipts to be trading income from a trade carried out in the UK under the new regime is that, subject to any applicable double tax treaty, non-UK tax residents will be liable to UK income tax on carried interest to the extent that it relates to services performed in the UK. This is already the position under the current regime in relation to carried interest which is deemed to be a disguised investment management fee (or DIMF) as a result of being income based carried interest due to a fund failing to satisfy the 40-month average weighted holding period test.
The government has acknowledged that where the UK deems a
receipt of carried interest by a non-resident to be business
profits/trading income derived from the UK, and the jurisdiction of
the non-resident individual taxes such receipt of carried interest
as investment income (as a gain), there is a potential for such
individual to be double taxed or at least for such individual to
need to engage the mutual agreement procedure/process in the
relevant double tax treaty for the tax authorities to resolve the
double tax outcome (which is an uncertain and lengthy process). The
government has noted that this position may discourage fund
managers from choosing to work in the UK.
Accordingly, the government intends to introduce three statutory
limitations on the territorial scope of the taxation of qualifying
carried interest. Although not explicitly stated in the
consultation, it appears that non-qualifying carried interest will
continue to be taxed in the same way as DIMF under the current
rules (with reliance needing to be placed on the mutual agreement
procedure in the event of a dispute between tax authorities). These
statutory limitations will apply in addition to any relief
available under an applicable double tax treaty.
The three statutory limitations to the tax treatment of qualifying
carried interest received by non-UK residents to be set out in
domestic UK law are as follows:
- Any services performed in the UK before 30 October 2024 will be deemed to be non-UK services.
- Any UK services performed in a tax year in which an individual is neither UK tax resident nor spends at least 60 days in the UK in the relevant tax year (a new UK workday threshold test) will be deemed to be non-UK services.
- Any UK services performed in a tax year will also be treated as if they were non-UK services if 3 full tax years (in addition to the then current tax year) have passed during which time the individual was neither UK resident nor met the UK workday threshold.
Additionally, to provide clarity on the proportion of carried interest subject to UK tax based on the UK services performed, the government has confirmed that the apportionment will be determined on a days- worked- in- the- UK basis i.e. a time-based apportionment method as opposed to other methods of apportionment.
Payment on Account for Self-Employed
As a point of detail, since carried interest will be taxable as deemed trading income in the UK, the government has confirmed that such income will factor into the payment on account rules for self-employed individuals. Accordingly, self-employed individuals may need to consider making claims to reduce or cancel payments on account to avoid overpayments of tax following a tax year in which such individual has received carried interest taxable as trading income.
Summary of Previously Announced Changes
As a reminder, the following changes announced in the 2024 Budget Consultation are confirmed:
- Exclusive charge: The new carried interest charge on carried interest will be an exclusive charge, meaning that there will no longer be a requirement to look at the underlying nature of the sum received (capital gain, dividend, interest). This is a major simplification to the current regime from an administrative and fund structuring perspective and could result in a reduced effective rate of tax for carried interest largely comprised of interest (e.g. credit funds) or dividends.
- Abolishment of ERS exclusion from the AHP Condition: The employment-related security (ERS) exclusion from the 40-month average holding period test will be abolished. The AHP Condition will apply equally to self-employed and employed investment managers.
- HMRC/BVCA memorandum of understanding: The existing approach to carried interest and the ERS rules for employees will continue to apply as they currently do.
Next Steps
The government aims to publish draft legislation for consultation and comment before the publication of the Finance Bill 2025-26. We understand that the government will publish this draft legislation before the summer recess of Parliament (before the end of July 2025).
Please get in touch with a member of Dechert's Global Tax team if you would like to discuss how the proposed changes may affect you.
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.
