Fundamental Changes to the United Kingdom's Taxation of Carried Interest Regime

What Happened?

The Finance Bill 2025/26 proposes substantial changes to the United Kingdom taxation of carried interest.

From 6 April 2026, carried interest arising to affected UK taxpayers will generally be taxed within the income tax regime as profits of a deemed trade. Where the carried interest is “qualifying,” a 72.5% multiplier will apply to the taxable amount, giving an effective top rate of approximately 34.1% for additional rate taxpayers (including Class 4 NICs). Non‑qualifying carried interest will be taxed at rates of up to 47%.

The Bill also proposes important revisions to the average holding period or “AHP” rules (the successor to the current income-based carried interest regime) which determine whether carried interest is “qualifying.” In parallel, the Bill resets the territorial scope of the carried interest regime for non‑residents.

An annual irrevocable election will allow ordinary trading principles to apply instead of the deemed‑trade carry rules for that year. In addition, amounts actually taxed as employment income will be excluded from the new carried interest charge. Subject to that, however, the employment‑related securities exclusion will be removed under the proposed changes so that the regime can apply to ‘employee’ carry as well as to LLP members. Consequently, a section 431 ITEPA 2003 election will no longer, by itself, keep awards outside the carry rules (albeit that such an election will frequently still be beneficial for carried interest holders that are employees).

Overall, these are highly significant reforms for private equity, private credit, hedge and other alternative asset strategies. The changes affect rate, character, territorial scope and compliance and will be central to structuring and remuneration decisions from 2026 onwards.

The Current Regime

Under the rules applying up to 5 April 2026, carried interest that qualifies for capital treatment is charged to capital gains tax. For individuals, the top rate on gains on carried interest is 32% for the 2025–26 tax year.

The income-based carried interest (“IBCI”) rules can instead bring carried interest into the income tax charge for individuals where, broadly, the fund’s weighted average holding period for investments is short. In outline, none of the carried interest is ‘qualifying’ if the fund’s average holding period is less than 36 months; a sliding scale applies between 36 and 40 months; and all carried interest is “qualifying” at 40 months or more.¹

Separately, the disguised investment management fee or “DIMF” rules charge sums to income tax as trading profits where the reward is not sufficiently profit‑related, variable and at risk.² Where carry falls within DIMF, it is taxed as trading income. Even where carry is otherwise sufficiently profit‑related to fall outside DIMF, it can still be taxed as income under the IBCI rules if the fund’s average holding period is under 36 months.

Under the current regime, some arrangements use employment‑related securities—often with a Section 431 ITEPA 2003 election—so that the ERS exclusion from IBCI applies. If so, a later disposal is generally charged to capital gains tax, which can produce a lower effective rate.

IBCI

Central to the current regime are the above mentioned IBCI rules, under which carried interest can be taxed wholly or partly as income if the fund’s average holding period (“AHP”) for relevant investments is less than 40 months.

In essence, the IBCI rules apply a mechanical AHP test in which each separate acquisition is treated as a distinct investment with its own holding period, feeding into the overall AHP.

For example, A fund invests £300m in Asset 1 and £200m in Asset 2. By the relevant date for the AHP test, Asset 1 has been held 34 months and Asset 2 for 50 months. Use time to disposal if already sold; otherwise, use time held up to the relevant date.

AHP = [(300 × 34) + (200 × 50)] / (300 + 200) = (10,200 + 10,000) / 500 = 40.4 months.

Outcome: AHP ≥ 40 months, so all carried interest is “qualifying” (i.e., none is charged as income under IBCI).

This means that bolt‑on acquisitions and partial disposals will, as a starting point, reduce the AHP unless one of the specific modification rules applies. The modification rules are highly prescriptive but, where their conditions are met, they can be determinative of whether carried interest is taxed mainly as capital or as income.

For example, for real estate funds, where the fund holds a “major interest” in land, follow‑on purchases of adjacent land and staged disposals may be aggregated and treated as part of a single investment for AHP purposes, subject to detailed gateway conditions.³ Special provisions of similar application also exist for venture, significant equity stake and controlling equity stake funds, as well as for funds of funds and secondary funds, each as defined.⁴

In practice, these rules tend to lengthen the measured holding period of the fund’s relevant investments, increasing the likelihood that carried interest is “qualifying” and therefore taxed on capital gains principles. In each case, however, the special provisions are tightly drawn and can be difficult to access in practice. The limited routes for direct lending funds to benefit from the IBCI/AHP modifications are particularly challenging, the default position being that carried interest from such funds is treated as income unless narrow exceptions apply.⁵

Investment Scheme

Both the current and the proposed regimes apply only where the carried interest holder performs “investment management services” in relation to an “investment scheme.” In practice, this generally captures collective investment schemes and investment trusts and—under the reformed regime—AIFs (including those that are not collective investment schemes).

Accordingly, where a manager is granted an interest in a partnership that owns and operates a trading business (rather than an investment scheme), and works in that trading business, the carried interest rules will not usually apply. Instead, ordinary income tax and capital gains tax rules will govern the tax treatment.

Reform

The Finance Bill 2025/26 proposes substantial changes to the UK carried-interest rules, including the measures outlined below.⁶

From 6 April 2026, carried interest will be charged to income tax as profits of a deemed trade rather than to capital gains. Anti-overlap provisions will prevent double taxation where amounts are also charged as employment income. As a result, income tax and Class 4 National Insurance contributions (“NICs”) will apply, giving a top combined rate of up to 47% for additional rate taxpayers.

“Qualifying carried interest” will benefit from a discounted effective rate of approximately 34.1% through application of a 72.5% multiplier to the taxable amount. Broadly, qualifying status is driven by the average holding period (AHP) mechanics described below, which are designed to favour longer-term, risk-based strategies.

An irrevocable annual election will allow individuals, where the underlying amounts would otherwise fall within ordinary trading principles, to be taxed on that basis instead. Where the election applies, the 72.5% multiplier will not apply, but standard trading reliefs (for example, relevant expense deductions and loss reliefs subject to the usual restrictions) will be available and may improve the holder’s after-tax position in some cases.

The IBCI rules will be carried across as the AHP test and applied to all carried interest holders, including employees, with targeted improvements. As under the existing rules, where the fund’s AHP is under 36 months none of the carry is qualifying; between 36 and 40 months a proportion qualifies on a sliding scale; and at 40 months or more all of the carry qualifies.

The employment-related securities (ERS) exclusion from the existing regime will be abolished so that—subject to provisions preventing double counting as between employment income and the new carried interest charge—"employee” carry is fully within scope.

No grandfathering or broad transitional relief is proposed. The new rules will apply to all carried interest arising on or after 6 April 2026, regardless of when the fund was established or the carry was granted.

The territorial scope will be reset and broadened for non-resident individuals, with specific interactions with the UK foreign income and gains (FIG) regime discussed below.

AHP

The reformed AHP rules within the new regime will remain technically complex. That said, there are meaningful improvements that should make the rules more workable in a number of common scenarios. From a taxpayer’s perspective, the objective is, where possible, to demonstrate that the fund’s AHP is at least 40 months or, failing that, between 36 and 40 months, so that at least a proportion of the relevant carried interest is qualifying.

Debt and private credit strategies are the principal beneficiaries of these changes. The default presumption that carried interest granted by a debt fund is non‑qualifying will no longer apply. In addition, for both credit and other funds, the holding period for a debt investment will generally start when the fund becomes unconditionally obliged to advance funds, which will often lengthen the holding period under the AHP regime. Early borrower prepayments will not ordinarily shorten the holding period where the fund both intended and was able to hold to maturity and the borrower’s decision was not influenced by the regime. Extensions on substantially the same terms, and restructurings that leave the fund with substantially the same economic exposure, will generally not be disposals for AHP purposes.

For credit funds, once a ‘significant’ debt investment has been made—broadly, at least £1 million or at least 5% of the total amounts raised or to be raised from external investors—subsequent follow‑on debt and associated equity (that is, shares in the debtor or another member of the same consolidated group) are treated as part of that original investment from the date of the significant investment. A disposal is generally not recognised for AHP purposes until, immediately after the disposal, the base amount held in associated investments is less than 50% of the greatest base amount held in those investments at any time. These rules reduce the risk of artificial shortening of holding periods.

Alongside other improvements to the AHP rules, the unwanted short‑term investments disregard will also be broadened and streamlined. A single 12‑month window will apply, without asset‑type limitations, where—subject to other conditions—the asset was necessary to effect the main investment of which it formed part and there was a firm, evidenced intention to sell within that window. The disregard can apply even if the sale occurs after 12 months, provided safeguarding conditions are satisfied, including that the profits from the disposal do not have a significant bearing on whether, or how much, carried interest arises.

Territorial Application

As noted, the territorial application of the reformed regime will be broader for non‑UK residents.

Under the current regime, non‑UK residents are generally outside the scope of UK CGT. Accordingly, to the extent carried interest is taxed as capital under TCGA 1992, it is ordinarily not chargeable to UK CGT for non‑residents (ignoring certain UK real estate-related gains).

From 6 April 2026, however, carried interest will generally be taxed as deemed trading income. Non‑UK residents will therefore be within UK income tax to the extent the profits are attributable to UK‑performed investment management services, subject to any applicable double tax treaty relief.

The UK‑taxable portion is determined by a mandatory time apportionment: the number of UK workdays divided by total applicable workdays in the relevant period. For these purposes:

• A UK workday is a day in the relevant period on which the individual spends more than three hours performing investment management services in the United Kingdom (time spent while travelling to or from the United Kingdom is ignored).
• Applicable workdays include any day in the relevant period on which the individual performs investment management services in relation to any investment scheme, not only the scheme from which the carried interest is paid.
• The relevant period broadly is the period from first external investor admission (or, if later, the first day the individual performs investment management services) to the earlier of the last day in the tax year on which carried interest arises to the individual or the day those services cease.⁷

There are targeted easements for qualifying carried interest:

• Pre‑30 October 2024 services: UK services performed before 30 October 2024 are treated as non‑UK (i.e. such days are not “UK workdays”) when apportioning qualifying carry.
• 60‑day non‑resident year rule: In any tax year in which the individual is non‑UK resident and has fewer than 60 UK workdays, those UK workdays are treated as non‑UK for qualifying carry.
• Three‑year reset: After three consecutive non‑resident tax years, each with fewer than 60 UK workdays, UK workdays before that three‑year period are disregarded when apportioning qualifying carry.⁸

These easements apply only to qualifying carry, with one important extension. The 60‑day protection also applies to non‑qualifying profits that are ‘anticipated qualifying profits’ where, on the first UK workday in the relevant period, it was reasonable to assume the carry would be qualifying. In those cases, UK workdays in a non‑resident tax year are treated as non‑UK workdays for those profits.

Evaluation

The proposed reforms to the UK carried interest regime are highly significant. While the effective rate on qualifying carried interest increases only marginally from the current 32% capital gains rate to approximately 34.1%, all carried interest will now fall within the income tax regime. Moreover, the c.34.1% rate of tax depends on the 72.5% multiplier, which can be seen as policy lever that could be increased in future.

Under the proposed reforms, carried-interest holders will also fall within the payments on account regime, requiring income tax to be paid in two instalments during the tax year. The recent Budget’s reference to “timelier tax payments” for income tax self-assessment taxpayers signals the possibility of accelerated cash‑flow obligations, which could further prejudice fund executives.⁹

A pivotal change is the extension of the regime to effectively all carried interest holders, including employees, not only LLP members and others taxed on a self‑employed basis. As a result, potentially burdensome features such as the average holding period (AHP) mechanics will need to be monitored more widely than before. As explained, there is no grandfathering or broad transitional relief: the new rules will apply to carried interest arising on or after 6 April 2026, irrespective of when arrangements were established.

As also noted, the regime applies only where the carried interest holder performs investment management services directly or indirectly in respect of an investment scheme. In practice, this should exclude most forms of “sweet equity” granted to management within a private equity holding structure. However, there is no longer a route for employees to fall outside the carry rules via section 431 elections where they are performing such services (though in most cases such an election will still be beneficial for carried interest holders that are employees).

The territorial scope of the new regime for non‑residents warrants particular attention, as does its interaction with the UK FIG regime for certain new UK residents, which is potentially complex. In essence, where an individual becomes UK‑resident and receives carried interest while UK‑resident that relates to services performed while non‑UK‑resident but which would otherwise be attributable to UK workdays, FIG relief can apply (within the individual’s four‑year FIG window) if:

• The carry is qualifying; and
• A relevant apportionment easement applies (for example, the pre‑30 October 2024 disregard, the “<60 UK workdays” non‑resident‑year rule, or the three‑year reset)). ¹⁰

By contrast, to the extent the carry is non‑qualifying and attributable to UK workdays, it is fully taxable in the United Kingdom and FIG does not apply (though the non-UK pre-arrival portion may still fall within FIG).

Overall, the new regime will require close monitoring whenever carried interest arrangements are designed for fund executives and others within scope. The improvements to the AHP (formerly IBCI) rules are welcome and should, in many cases, make it easier to structure qualifying carry. That said, the regime remains complex, its reach for non‑resident executives has increased, and—given its interaction with the FIG regime—the position of executives relocating to the UK will often require detailed modelling and record‑keeping around workday apportionment and eligibility for easements. Likewise, non-UK resident executives (and their employers) should carefully monitor their UK workdays and avoid inadvertently tripping the 60 UK workday threshold, where possible.