Revised tax treatment of carried interest: draft legislation

As part of this summer's "L Day", the government has published draft legislation for inclusion in the Finance Bill 2025-2026 to give effect to the new tax regime applicable to carried interest. The draft legislation runs to some 48 pages, and follows on from the recent publication of a consultation response document, which confirmed that the new regime would come into effect from April 2026.

There is now a short technical consultation period on the draft legislation until 15 September.

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". This was followed in the 2024 Autumn Budget by proposals to tax all carried interest as trading profits subject to income tax and Class 4 NICs, whilst adjusting the amount of 'qualifying' carried interest subject to such tax by applying a 72.5% multiplier.

Consultation on the details of this new regime followed with the response document published in June 2025. The response document confirmed that proposed minimum co-investment and minimum personal holding period requirements would not be included the new regime. The document also set out new limitations which the government intends to introduce with regard to the territorial scope of the new regime.

Draft legislation

This draft legislation is designed to give effect to the revised tax regime for carried interest which will sit wholly within the income tax framework, with carried interest treated as trading profits and subject to income tax and Class 4 National Insurance contributions. It runs to some 48 pages of detailed provisions and will take some time to digest in full.

The revised tax regime will apply where an individual performs investment management services directly or indirectly in respect of an investment scheme under any arrangements and carried interest arises to the individual under those arrangements. The legislation will provide that the individual is treated as carrying on a trade and the carried interest (less any permitted deductions) is treated as the profits of that trade.

Where the carried interest is 'qualifying', the legislation will provide that the amount to be treated as trading profits is 72.5% of the 'qualifying profits'. The qualifying profits is the amount of qualifying carried interest less any applicable permitted deductions. The amount of carried interest which is 'qualifying' is depends on the average holding period of the relevant investment scheme.

The legislation will also:

• define what is meant by 'carried interest' (using the same definition as that which the disguised investment management fee regime uses)
• define the territorial scope of the revised regime
• detail the amounts which are to be treated as 'permitted deductions'
• set out certain circumstances in which carried interest is deemed to arise to an individual notwithstanding it actually arises to another person (again, copying across equivalent provisions from the disguised investment management fee regime)
• explain how to determine the average holding period of an investment scheme
• provide for an election to be made to treat carried interest as arising at an earlier time.

From an initial review of the draft legislation, some notable points include the following:

• The definition of "profits" on which the carried interest definitions are anchored continues to include unrealised profits, which is helpful for those funds that pay carried interest on such profits
• The legal nature of the underlying return is totally irrelevant - whether amounts fall to be treated as "qualifying carried interest" is entirely dependent on the average holding period, and those periods replicate the current IBCI rules, so to be 100% qualifying carried interest the average holding period needs to be 40+ months. The only exception to this is where it is chargeable by virtue of section 62 (earnings) or Part 7 of ITEPA 2003 (employment income relating to securities). To that extent, the original promise of an "exclusive regime" has not been delivered upon
• The draft legislation includes a specific provision which treats tax distributions as carried interest which is a helpful improvement to the existing rules
• The "permitted deductions" concept covers the amount originally paid (minus any amount already deducted in respect of an earlier year)
• There are then detailed rules for how you work out the time of acquisition for various types of investment, many of which are again carried over from the income based carried interest rules in the existing disguised investment management fee regime. The new rules largely treat credit funds in the same way as other funds, which is a welcome change.
• It is explicit that double tax relief is only in relation to UK tax (i.e. the position that HMRC has recently taken on section 103KE TCGA). The ability to make an election to be chargeable to UK tax as profits arise (rather than when they are received) is preserved, with grandfathering for elections previously made under section 103KFA TCGA.  This is intended to allow individuals who are taxable on the carried interest in another jurisdiction (such as the US) on an arising basis to more closely align the timing of the tax charges with a view to facilitating a double tax treaty relief claim.
• Re territoriality, there are a series of complicated rules where an individual performs investment management services both inside and outside the UK, with various specific rules for which days are counted as UK work days for non-residents.

Next steps

The draft legislation is now subject to an eight-week technical consultation period with comments required in writing by no later than 5pm on Monday 15 September. Comments should be sent to carriedinterest@hmtreasury.gov.uk. Following the consultation, HM Treasury and HMRC will be hosting Technical Working Group sessions to focus on the key themes of the feedback.

It is intended that the final legislation will be introduced in Finance Bill 2025-26 with effect from April 2026.