L-Day: UK carried interest draft legislation - initial observations

For carried interest to be viewed as ‘qualifying’, it must meet the Average Holding Period (AHP) conditions, which are largely based on the existing Income Based Carried Interest rules, i.e. applying a 40-month weighted average holding period test. Those rules have been adapted, in line with the announcements in the Update Document, to:

• Remove the exclusion for carried interest arising in respect of an employment-related security; ·
• Make changes to the AHP rules so that they work more effectively for credit funds and fund of funds / secondaries funds; and ·
• Broaden the category of unwanted short-term investments that can be ignored for the purpose of the AHP calculation.

For credit funds, instead of carried interest arising from a direct lending fund being deemed trading income unless it meets a narrow exemption, there will be a gateway definition of a credit fund. Where this definition is met, the benefit of T1/T2 provisions allowing the backdating of follow-on investment and deferral of certain interim disposals will apply.

The fund of funds and secondaries rules have been simplified and made easier to access

The following points have been clarified:

Operation of single charge

The definition of ‘permitted deductions’ and the double tax credit provisions have some detailed implications which slightly differ to the existing regime and require careful attention on different fact patterns.

Ambit of carried interest charge

The existing charge applies to an investment manager performing investment management services in respect of an investment scheme. The definition of ‘investment scheme’ is being broadened to include an Alternative Investment Fund as well as a Collective Investment Scheme. There are also changes to the meaning of carried interest arising, which may accelerate the tax point in certain scenarios.

Territorial matters

The legislation confirms that non-UK residents will be taxed on carried interest arising in relation to the UK workdays as a proportion of overall workdays, subject to the three exceptions already announced in relation to qualifying carried interest (60 UK workday de minimis, exclusion of pre 30 October 2024 workdays, and the disregard of UK workdays prior to a period of three tax years of non-residence and less than 60 UK workdays). The definition of ‘UK workday’ has now been specified, and it is a day on which the individual spends more than three hours performing any investment management services in the UK. That is to be contrasted against the general workday definition used in the calculation, which is a day on which the individual performs any investment management services.

Temporary non-residents

In changing from a capital gains tax framework to a trading income framework, for persons realising carried interest prior to the introduction of the new regime, but who return to the UK within the (broadly) five year period on or after 6 April 2026, amounts will be subject to tax as qualifying carried interest in the year of return. This means the treatment and rates in force at the time the carried interest arose will not be preserved.

Finally, the issue of Payments on Account (PoAs) for income tax has not specifically been referred to and it is expected that the position will turn on the general legislation and so, in line with the Update Document, PoAs will apply to carried interest in the usual way for any other item subject to income tax, with no reliefs or concessions.

It should also be noted that a two month period of consultation has started ending on 15 September 2025, and the legislation is therefore subject to change.

For further information please contact:

• Eli Hillman