June 2025 Government update on Carried Interest tax reform

The other key highlights are as follows:

• Revised tax regime: As expected, a new regime for the taxation of carried interest will be introduced with effect from April 2026. Under the new regime, carried interest will be taxed under the Income Tax framework, and classified as trading profits. A special 72.5 percent multiplier will apply where carried interest is ‘qualifying’. Trading profits may also be subject to Class 4 NICs such that qualifying carried interest will be subject to tax at an effective rate of 34.075 percent for English additional rate taxpayers;
• Minimum co-invest and minimum holding period conditions: The Government has opted not to proceed with a minimum co-investment requirement and a minimum carry holding period condition, due to potential complexity;
• Territorial scope adjustments: The scope of the revised tax regime means that UK taxation will apply to carried interest related to services performed in the UK, with specific limitations to alleviate double taxation. 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 current tax year) have passed during which time the individual was neither UK tax resident nor met the 60 day UK workday threshold. Double taxation treaties may also be applicable; and
• Income Based Carried Interest (IBCI): The document reconfirms that from April 2026 carried interest that is an employment related security will not be excluded from the IBCI rules. The IBCI rules broadly require that, in order for carried interest to be qualifying, the underlying investments from which it is derived must be held for an Average Holding Period (AHP) of more than 40 months. The document also confirms that the Government will make targeted amendments to the AHP requirement with the intention that the rules should operate effectively for private credit, secondary, and fund of funds strategies.

Please see below for further detail in relation to: (i) the Territorial Scope adjustments, and (ii) proposed changes to the IBCI rules.

In the update document the Government has restated the principle that it views carried interest to be, in substance, a reward for the provision of investment management services, and accordingly the reward should be taxed in the UK to the extent services are performed in the UK, even for persons non-resident in the UK at the time carried interest arises.

The Government's view, communicated during the consultation process, is that since carried interest will be characterised in UK legislation as a reward for services, double taxation agreements would typically accord primary taxing rights to the UK for carried interest received by a non-resident person attributable to a personal UK permanent establishment. Respondents had raised that this leaves taxpayers to the uncertainty of seeking double tax relief in other countries, involving issues where those countries characterise carried interest differently, e.g. as an investment return. The Government will not change the approach towards double taxation, however, it has announced it will introduce three statutory limitations on the territorial scope of the new regime to balance its aim of "ensuring that the rewards for work which takes place in the UK are fairly taxed" whilst maintaining the UK's attractiveness as an international hub for asset management activity:

• Firstly, any services performed in the UK prior to 30 October 2024 will be treated as if they were non-UK services;
• Secondly, a de minimis of 60 work days in the UK will apply to persons non-UK tax resident in the relevant tax year; and
• Finally, UK based services performed in a tax year will be treated as if they were non-UK services if three full tax years in addition to the current tax year have passed for which the individual was neither UK tax resident nor met the 60 work day threshold.

To provide clarity on the apportionment of carried interest between investment management services performed in the UK and those outside of the UK, a time-based apportionment method will be mandated by reference to the number of UK workdays. The Government has stated that it will continue to work with stakeholders on technical matters regarding the double tax treaty aspects.

The document confirms that the Government will make amendments to the AHP condition by removing the Direct Lending Fund rule which potentially treats all carried interest arising from Direct Lending funds as failing the AHP condition, regardless of the weighted average holding period. The rule will be replaced with new rules applying a T1/T2 concept for calculating the AHP. As a consequence, the ‘loan to own’ rules will also be removed as these investments will be dealt with under the T1/T2 framework. The T1/T2 rules will deem debt investments to be made and disposed of at specific times, better reflecting commercial realities and streamlining compliance for credit funds. The T1/T2 framework within other fund categories will allow the AHP to be calculated in a preferential manner. For example, within certain strategies investment can be treated as made when the investment is first made (T1) instead of at the time of subsequent top-up investments (T2). The document does not elaborate further on how the framework will operate for private credit strategies. For example, whether T1 will be when a commitment is entered into and whether T2 will track subsequent amounts invested to this date or reference the expected terms of a facility. It also remains to be seen how refinancings and enforcements will be incorporated into the new rule.

In addition:

• The existing T1/T2 rules for secondary and fund of fund strategies will be replaced with a single test which is intended to better reflect commercial practice and to streamline compliance;
• The rules for unwanted short term investments will also be reformed in order to address situations where bundles of assets are acquired, or investments are syndicated. This is a welcome development as the current rules are rigid as, in order to qualify, it is necessary for short term investments to have no impact on fund performance; and
• Other technical amendments will be made including in relation to the treatment of ‘tax’ distributions.

The document notes that the AHP amendments are intended to remove arbitrary or distortive outcomes for particular investment strategies, while retaining the core existing features.

The measures will be contained in Finance Bill 2025–26 and draft legislation on the carried interest changes will be published before Monday 21 July 2025. The draft legislation is said by HM Treasury to resolve further technical points and there will be continued consultation with stakeholders.

For further information please contact:

• Eli Hillman