The Chancellor of the Exchequer, Rachel Reeves MP, presented her first Budget to Parliament on 30 October 2024. In it, she announced both tax rate increases and also proposals which would fundamentally change the tax treatment of carried interest. Alongside the announcement, HM Treasury has published a further consultation/response document on the taxation of carried interest, following its call for evidence in June 2024 which received over 100 responses.

Executive Summary

In summary, the government has announced a two-stage reform. Firstly, from 6 April 2025 the tax rate applicable to carried interest which qualifies for capital gains treatment will rise to 32% on a temporary basis. Then, subject to the further consultation, 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 certain conditions set out in a modified form of the income based carried interest rules (IBCI) (yet to be confirmed in detail - but see below) the carried interest will be 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 modified IBCI rules will be taxable at full marginal income tax rates and national insurance at a maximum rate of 45% income tax plus 2% NICs. We summarise the high-level proposals below.

Helpfully, it is proposed that the new 2026 trading income 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 components of the carried interest sum received (as to whether capital gain, dividend, interest). This is a major (and welcome) simplification to the current regime from an administrative and fund structuring perspective and this could (subject to the reforms to the IBCI rules) result in a reduced effective rate of tax for carried interest largely comprised of interest (e.g. credit funds) or dividends.

On the other hand, it is also proposed that the employment related security (ERS) exclusion from the IBCI rules that exempts carried interest received by employees from the "40-month average holding period" test and related aspects of the IBCI rules for loan origination funds will be abolished. This change is likely to materially affect the tax treatment of existing carried interest arrangements of private credit funds accruing after April 2026 that were structured on the basis that the IBCI rules (and the associated direct lending fund rules) did not apply to the participants who were employees. The government recognises that this change to the IBCI rules will likely impact private credit fund managers and at this stage has promised to consult on making "appropriate amendments to the IBCI rules while ensuring that IBCI rules continue to limit qualifying carried interest to funds engaged in long-term investment activity".

In one respect, these proposed changes allow the government to technically meet their manifesto pledge of ending the carried interest "loophole" and to tax carried interest as "remuneration". However, to its credit the government has clearly carefully considered the responses to the call for evidence over the summer and has concluded that whilst carried interest should be taxed as ordinary income, it does have unique characteristics which set it apart from other types of remunerative reward (hence the bespoke income tax regime). Helpfully, the government has also explicitly recognised the importance of preserving the UK's competitive position as global asset management hub and the importance of a competitive carried interest regime in this regard. The compromise in approach following the call for evidence process is evident from the budget forecast for 2028-29 in which the additional sums raised for HM Treasury from these changes is estimated to be in the region of £80 million rather than the £565 million which was originally set out in the Labour Party manifesto.

Next Steps

The government intends to establish working groups with stakeholders to explore the technical details in relation to the announced policy changes ahead of the publication of draft legislation during 2025.

Stakeholders are also invited to comment on the additional IBCI conditions being consulted on. The consultation on the additional IBCI conditions will end on 31 January 2024.

HM Treasury's summary of responses and proposed next steps and consultation can be found here.

Summary of Changes

Changes with effect from 6 April 2025

From 6 April 2025, carried interest receipts which qualify for capital gains tax treatment will be taxable at a capital gains tax rate of 32% (as compared to 28% today). However, it will remain necessary to look through to the underlying nature of the returns and it may be that the effective rate of tax will exceed 32% if returns comprise interest or dividends.

Changes with effect from 6 April 2026

Subject to the further consultation process, it is proposed that from 6 April 2026 carried interest will move fully into the income tax framework. The government has, however, indicated the following:

• All carried interest receipts will be taxed as trading income but potentially taxed at a lower rate if certain conditions can be met. All carried interest will be treated as deemed trading profits and subject to income tax and class 4 national insurance contributions at 2% (as if it were a disguised fee). This would result in an effective tax liability of 47%. However, taking into account the unique characteristics of carried interest, "qualifying carried interest" will be subject to income tax and class 4 NIC by applying a 72.5% multiplier for additional rate taxpayers (45% income rate payers) on the amount of carried interest received. This means that the amount of deemed trading profit represented by carried interest will be multiplied by 72.5%, and this net amount will be subject to income tax at the applicable marginal rate and class 4 NICs. If we assume a 45% rate taxpayer, and a receipt of qualifying carried interest of £100, this would be £100 x 72.5% = £72.5. This sum (£72.5) is then subject to 45% and 2% NIC giving rise to £34.08 of tax. This produces an effective tax rate of 34.08% for recipients of carried interest that are additional rate taxpayers if the qualifying conditions can be met.

• Modified IBCI Rules. Carried interest will be qualifying where it is not subject to modified IBCI rules. This means that the 40-month average holding period will need to be satisfied plus additional conditions that the government will continue to consult on. The government is considering the following possible additional conditions to the IBCI rules:
  • Minimum Co-Invest Condition: a new requirement to have a minimum co-investment invested by the fund managers into the funds they manage in order to fall outside the IBCI rules (with the indication being that this would be assessed on a collective basis rather than at an individual level); and/or
  • Minimum Holding Period Condition for Individual: a requirement to have a minimum time period being satisfied assessed at the level of the individual between the date of award of the right to receive carried interest and the date of the receipt of the carried interest in cash terms.

Of the two new potential conditions, it appears that the government is leaning towards the time period condition as its preferred additional condition.

• 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 (subject to the reforms to the IBCI rules) 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 IBCI Rules. 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 and employed investment managers.

• Impact on Private Credit Funds. The government recognises that the amendment to the IBCI rules will likely impact private credit funds. The government will therefore consult to consider "appropriate amendments to the IBCI rules while ensuring that IBCI rules continue to limit qualifying carried interest to funds engages in long-term investment activity". It is recognised that some aspects of the IBCI rules do not work as well as they might for private credit funds and therefore HMRC will consult on ways the rules might be improved.

• HMRC/BVCA Memorandum of Understanding. Helpfully, the government appears to have confirmed that the existing approach to carried interest and the ERS rules for employees will continue to apply as they currently do.

• No Grandfathering. There will be no grandfathering of existing carried interest awarded prior to the introduction of these amendments. Accordingly, all carried interest which arises from April 2026 will be subject to the new regime. Therefore, these changes will have material implications for many existing funds with carried interest arrangements.

• No Change to Co-Investment Tax. There are currently no plans to change the taxation treatment of co-investment.

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.

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