Tax

What fund managers need to know about the UK's new carried interest tax regime

Published on 20th August 2025

A revised regime for carried interest comes into effect from 6 April 2026 bringing it into the UK income tax framework 

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The carried interest tax regime, following a one-year interim increase in the applicable rate of Capital Gains Tax to 32% for carried interest returns that took effect from April this year, will face complete structural reform from April 2026. This will bring all carried interest returns into the UK income tax framework. The draft legislation for the new regime was published by HMRC on 21 July and remains subject to an eight-week consultation process.

The revised tax regime, which will apply to carried interest receipts arising on or after 6 April 2026, will tax any carried interest returns (regardless of the underlying character of the return) as "deemed trading income". Consequently, carried interest returns will be taxed at combined income tax and National Insurance contributions (NICs) rates of up to 47%.

Where the carried interest is "qualifying" (that is, where it meets the "average holding period" condition), a discount multiplier mechanism will apply meaning that returns will be taxed instead at an effective tax rate for additional rate taxpayers of around 34.1% (including NICs).

There will be no "grandfathering" or transitional provisions for carry structures already in place.

Scope of the new regime

The draft legislation for the new regime borrows many aspects from the current rules (in particular, from the income-based carried interest (IBCI) rules), including in relation to many of the definitions.

Overall, the new regime will apply where carried interest arises to an individual providing investment management services in respect of an investment scheme. Broadly, the definitions of carried interest and the term "arises to the individual" are similar to the definitions under the current rules. The definitions of "investment scheme" and "investment management services" have each been expanded to include alternative investment funds (AIFs) (which can include corporate funds) and the provision of investment advice (and any incidental or ancillary activity) respectively. Although there are subtle differences within the new rules, it is expected that, broadly, any carried interest that is caught by the current rules will continue to be caught by the new rules.

'Qualifying' carried interest

Any carried interest which is "qualifying" will be adjusted downwards for the purposes of the new regime (by applying a 72.5% multiplier), giving an effective tax rate of around 34.1%.

The percentage of carried interest that will be qualifying depends on the extent the fund from which the carried interest derives meets the "average holding period" (AHP) condition in relation to its investments and their overall value. Where the weighted average holding period across the fund's investments is 40 months or more, all of the carried interest will be qualifying. Where the average holding period is less than 36 months, none of the carried interest will be qualifying and there is a sliding scale between 36 and 40 months.

The government had considered introducing other qualifying conditions (in addition to the AHP condition) but abandoned these during the consultation process.

Average holding period

Under the new regime, the AHP condition broadly replicates the current IBCI rules (which will be repealed when the new carry regime comes into effect), with some welcome amendments in respect of certain historic areas of difficulty with the IBCI rules.

However, the impact for certain fund managers will be significant as the AHP condition will apply to all carried interest holders (that is, both employees and non-employees such as LLP members) whereas the current IBCI rules do not apply to carried interest held or acquired by UK employees. As a result, a greater range of funds and their fund managers will need to consider the AHP condition rules going forward.  

In terms of calculating the weighted average holding period, the starting point is that any separate injection of cash or acquisition of interests is treated as a new investment for the purposes of the calculation and, similarly, any part-disposal is treated as a disposal of an investment for the purposes of the calculation. Given this, the new rules contain provisions that effectively operate to extend or adjust the average holding period in respect of later follow-on investments or early part-disposals (and are broadly replicated from the IBCI rules). These are often referred to as "T1/T2" rules (for certain investment strategies) and are designed to ensure that, where appropriate, the holding periods reflect commercial reality. While replicating the IBCI rules, some refinements have been made to improve the AHP condition outcome for fund of funds, credit funds, significant equity stake funds, real estate funds and venture capital (VC) funds.

In welcome news, the "scheme director" condition, which was one of the conditions which needed to be met for applying the T1/T2 rules for VC funds and significant equity stake funds, has been replaced with a wider test which looks at whether the fund can exercise "relevant rights" in relation to the investment. This broadly means that it is no longer necessary for the fund to have the right to appoint a director of investee companies.

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) – this is a significant change compared to the current rules. The basis will be the number of "UK workdays" (which will require more than three hours of investment management services provided on any fund in the UK).

The government has recognised that that there may be uncertainties relating to other jurisdictions’ approach to the application of DTAs (especially where an individual might have a UK permanent establishment). The new rules therefore introduce certain statutory limitations on the territorial scope of the new regime and UK workdays are not to be treated as such for non-UK residents where:

  • They are prior to 30 October 2024 (the date of the Autumn Budget 2024 when the new regime for carried interest was announced).
  • They were in a tax year in which the individual did not meet the UK workday threshold (that is, 60 UK workdays):
  • They were in a period since which at least three tax years have passed where the individual was both not a UK tax resident and did not meet the UK workday threshold.

The above limitations only apply to qualifying carried interest – there are no such limits for non-UK residents with respect to non-qualifying carried interest.

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 by carried interest holders (that is, the advanced payments on account of their expected future tax liability). While the government has said 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 currently propose any concessions in this regard.

Osborne Clarke comment

There were no major surprises in the draft legislation published in July as it broadly follows the government's previous policy announcements and, although it is a major structural overhaul of carried interest taxation in the UK, the nuts and bolts of the regime borrow heavily from existing UK tax legislation.

The government has consulted widely on the reform of the carried interest rules and, while the draft legislation may still be tweaked before the final version is included in the next Finance Bill (following the Autumn Budget), we do not expect substantive changes. Nonetheless, there are a number of areas where we think further engagement with HMRC would be beneficial – and Osborne Clarke will be responding to the consultation in relation to these points.

The government is also expected to publish guidance to accompany the new rules, including around the AHP condition. To date, it has not published its guidance on the IBCI rules, so any guidance on the new regime would be welcome.

While there are some helpful improvements in the drafting for the new AHP condition (in particular, in relation to the scheme-director condition), as all fund managers will now have to consider the average holding periods of investments (rather than just fund managers who have limited liability partnership members as carried interest holders) there will be a greater administrative burden for fund managers and their advisers moving forward in relation to, in particular, calculating the average holding period and determining what carried interest is "qualifying".

If you would like to discuss any aspects of the new regime, do get in touch with any of the contacts below.

* This article is current as of the date of its publication and does not necessarily reflect the present state of the law or relevant regulation.

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