UK government makes concessions regarding new carried interest tax regime

The government announced in the Autumn Budget 2024 that it would reform the tax treatment of carried interest and published a consultation (within its Summary of Responses and Next Steps) on certain details of the regime to which Osborne Clarke responded.

On 5 June 2025 the government published its response and a policy update to its consultation.

Revised regime

Following an increase in the applicable rate of Capital Gains Tax to 32% for carried interest returns, which took effect from April 2025, a revised tax regime for carried interest will be introduced from April 2026. This will bring carried interest into the income tax framework.

From April 2026, carried interest returns will be taxed as "deemed trading income" (at combined income tax and national insurance contribution (NICs) rates of up to 47%), but where certain qualifying conditions are met, a discount mechanism will apply so returns are taxed instead at an effective tax rate for additional rate taxpayers of around 34.1% (including NICs).

Removal of additional qualifying conditions

In considering potential qualifying conditions, the government's consultation asked for feedback on the introduction of a minimum co-investment condition and a minimum personal holding-period condition (alongside the existing condition adapted from the income-based carried interest (IBCI) rules which looks at the fund's average investment holding period).

Both of these additional conditions were strongly opposed by respondents to the consultation, with many raising a number of practical challenges associated with implementing a co-investment condition (even if measured at a team level) and concerns that the minimum personal holding-period condition would make the UK less competitive compared to regimes in other jurisdictions.

Following the responses received as part of the consultation, the government has confirmed it will not proceed with either of these two additional qualifying conditions. The government concluded in its response that it considers the asset-level average holding period condition (or AHP condition), combined with the wider tax rules which apply to awards of carried interest, are effective in limiting qualifying carried interest treatment to long-term rewards.

Average holding period

As the government set out in its Summary of Responses and Next Steps last October, it will legislate to remove the exclusion for employment-related securities from the IBCI rules meaning that the AHP condition will apply to all carry holders (when historically it has only applied to non-employees).

Responses to the consultation highlighted practical difficulties faced by certain funds, particularly credit funds, funds of funds and secondaries funds, in applying the AHP condition to their long-term investment strategies. The government confirmed in its response that it will bring forward amendments accordingly to enhance the effectiveness of the AHP condition.

It has also agreed to address various technical issues with the AHP condition, including the application of the scheme director condition (which needs to be met for a fund to be able to apply certain special timing rules that ignore certain acquisitions and disposals in relation to calculating the average holding period).

The government is also expected to publish guidance to accompany the new rules, including around the AHP condition. To date it has never published its guidance on the IBCI rules, so this will be welcome.

Territorial scope of new regime

Under the new regime, non-UK residents will be subject to income tax on carried interest to the extent that it relates to investment management services performed in the UK, subject to the terms of any applicable double tax agreement (DTA).

The government has recognised in its response to the consultation that that there may be uncertainties relating to other jurisdictions’ approach to the application of DTAs. It therefore intends to introduce three statutory limitations on the territorial scope of the new regime.

In summary, 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 (60 workdays);
• where there is an applicable DTA, the UK services are attributable to a UK permanent establishment of the relevant individual.

Any services performed in the UK prior to 30 October 2024 (the date of the Autumn Budget 2024 when the new regime for carried interest was announced) will be treated as if they were non-UK services.

Payments on account

Under the new regime, income tax and NICs paid in the previous tax year on carried interest will be relevant to the calculation of any payments on account due. While the government recognises in its response that carried interest receipts can be "irregular and unpredictable in nature" and so payment on account amounts may be distorted year on year, it does not propose any concessions in this regard.

The government highlights that the same is true of other forms of trading profit and there is a mechanism for taxpayers to make a claim to reduce or cancel payments on account to avoid overpayments of tax.

Next steps

Draft legislation for the new regime will be published in July for technical consultation, with the legislation to be included in Finance Bill 2025-2026 to take effect from April 2026. The government will continue to work with stakeholders to finalise the technical detail.

Osborne Clarke comment

From the response document, it is clear that the government has taken into account the feedback from the industry and stakeholders during the consultation. It is especially encouraging that it has decided to abandon the proposed conditions for a minimum co-investment period and a personal holding-period before carried interest can be taxed at the lower effective rate of around 34.1%.

Consequently, the AHP test will continue to be the primary qualifying condition and it is welcome news that the government will use this opportunity to address current challenges in those rules – in particular in relation to the scheme director condition, which can be notoriously tricky in respect of venture capital funds.

While we await the publication of the draft legislation to assess the finer details, the broad changes made to the proposals should help support the competitiveness of the UK's asset management sector which is a key pillar in the government's approach.