UK taxation of carried interest: next steps

The government has published a response document to its consultation on the tax treatment of carried interest. The document, "The Tax Treatment of Carried Interest - Consultation on Qualifying Conditions: Government Response and Policy Update", confirms further details of the government's proposal to bring carried interest within the income tax regime from April 2026.

In particular, the response confirms that proposed minimum co-investment and minimum personal holding period requirements will not be included the new regime. The document also sets out new limitations which the government intends to introduce with regard to the territorial scope of the new regime.

Background

In June 2024, the new Labour government announced a call for evidence on the tax treatment of carried interest, considering that the current tax regime "does not appropriately reflect the economic characteristics of carried interest and the level of risk assumed by fund managers in receipt of it".

In the Autumn Budget 2024, the government published proposals to tax all carried interest as trading profits subject to income tax and NICs. However, the government proposed that taking account of the unique characteristics of the reward, the amount of 'qualifying' carried interest subject to tax will be adjusted by applying a 72.5% multiplier. The Autumn Budget announcements outlined how the revised regime will operate and committed to explore points of technical detail with stakeholders through the establishment of a working group.

In particular, the Autumn Budget announcements included consultation exploring the case for further conditions of access (in addition to the existing asset-level average holding period condition) in order for carried interest to be treated as qualifying, specifically:

• A minimum co-investment requirement, measured at team level;
• A minimum time period between a carried interest award and receipt.

Minimum co-investment requirement

The vast majority of respondents to the Autumn Budget consultation opposed the introduction of a minimum co-investment requirement even if measured at a team level. Respondents said such a requirement would be complex and impractical, making the UK tax regime for carried interest less competitive compared to other jurisdictions and potentially causing distortions in the market.

The government has now accepted that implementing a minimum co-investment requirement would have a number of practical challenges, with a risk of creating unintended and/or distortive outcomes. Reflecting this, and the conceptual distinction between carried interest and returns on co-investment, the government has announced that it will not proceed with the introduction of a minimum co-investment requirement.

Minimum holding period

The majority of respondents similarly opposed the introduction of a minimum time period requirement. Again, concerns were raised that it would make the UK less competitive compared to other regimes. The UK already has an asset-level average holding period condition, which requires that the relevant fund holds its assets for at least 40 months, on average, in order to access preferential tax treatment in full. No other carried interest regime has such a condition and a time period requirement measured at individual level. Respondents also noted that to the extent the government was concerned about carried interest being used as a short-term performance reward, protections already exist in the form of tax charges on awards of carried interest (including the employment related securities rules).

As a result of responses, the government has now announced that it will not take forward the proposal to include minimum holding period requirements. The government has accepted that the existing asset-level average holding period condition, combined with the tax rules which apply to

awards of carried interest, are effective in limiting qualifying carried interest treatment to long-term rewards. As a result, the government considers that the complexity associated with a minimum time period requirement would not be proportionate and will not be proceeding with its introduction.

Other issues

The response document also includes government response to a number of issues raised in the Working Group discussions. These include a  significant list of amendments to the asset-level average holding period (AHP) condition to ensure it operates effectively.

In addition, the government will make some amendments to the territorial scope of the regime. The deemed trade under the regime will be treated as carried on in the UK to the extent that the relevant investment management services are performed in the UK, with the effect that non-UK residents will be subject to income tax on carried interest to the extent that it relates to services performed in the UK (subject to the terms of any applicable double tax agreement). The response recognises, however, that there may be uncertainties relating to other jurisdictions' approach to the application of DTAs, in particular in cases where carried interest is treated as an investment return under another jurisdiction's domestic law. Although there are established mechanisms to resolve international tax disputes, the government acknowledges that the potential need to rely on such processes creates uncertainty, which in turn risks discouraging fund managers from choosing to work in the UK.

In recognition of this uncertainty, the government intends to introduce three statutory limitations on the territorial scope of the revised regime.

• In order to provide proportionate transitional rules, any services performed in the UK prior to Autumn Budget 2024 (30 October 2024) will be treated as if they were non-UK services;
• Any UK services performed in a tax year in which an individual is neither UK tax resident nor meets a new UK workday threshold will be treated as if they are non-UK services. The UK workday threshold will be met if an individual who is not UK tax resident spends at least 60 workdays in the UK in the relevant tax year;
• Any UK services performed in a tax year will also be treated as if they were non-UK services if three full tax years (in addition to the then current tax year) have passed during which time the individual was neither UK tax resident nor met the UK workday threshold.

The government also intends to provide clarity on how carried interest is apportioned between investment management services performed in the UK and those performed outside the UK. In order to provide certainty for taxpayers, as well as enable HMRC to effectively monitor compliance, the government will mandate a time-based apportionment method, by reference to the number of UK workdays in the relevant period.

As a result of these changes, the consultation response notes that qualifying carried interest which arises to a non-resident will only be subject to UK tax where it relates to services performed in the UK (determined by reference to the number of UK workdays) and all of the following apply:

• The UK services were performed within the previous three tax years;
• The UK services were performed in a tax year in which the individual was UK tax resident or met the UK workday threshold;
• Where there is an applicable DTA, the UK services are attributable to a UK permanent establishment of the relevant individual.

(This last point is in line with HMRC guidance on attributing taxation rights under a DTA in the case of the deemed trade of an individual investment manager. Guidance on this point can be found at is IFM36220 (Deemed Trade: Territorial scope of the deemed trade) and, more generally on the DTA relevance of the PE concept to an individual carrying on a business, at INTM264020 (Non-residents trading in the UK: domestic law permanent establishment/branch or agency)).

Next steps

The government will bring forward legislation for the revised tax regime for carried interest in Finance Bill 2025-26. Ahead of that, the government will publish draft legislation for technical consultation. In the meantime, officials will continue to meet with stakeholders, including through the technical working group, to undertake that technical consultation.