Autumn Budget 2024: Carried Interest

Top of the watch-list for most private capital managers at this year's Budget was what reforms the Government would make to the UK's carried interest tax regime.

As announced at the despatch box, the headline carried interest capital gains tax rate will increase from 28% (for higher and additional rate taxpayers) to 32% for the 25/26 tax year. However, this is just a one year stop gap, as the Government intends to introduce major structural reforms to the carried interest rules from 6 April 2026 onwards. Taking inspiration from the German regime, carried interest arising from April 2026 will be brought fully within the UK income tax code, and taxed as deemed trading income (at combined income tax and national insurance contribution (NIC) rates of up to 47%), regardless of the underlying character of the return. However, a discount mechanism will apply to so-called "qualifying carried interest" (discussed below). Under this mechanism, 27.5% of any qualifying carried interest will be taken out of the UK tax net, resulting in an effective tax rate for additional rate taxpayers of ~34.1% (72.5% x 47%).

Whilst the discount mechanism will significantly reduce the UK's headline carried interest tax rate below that applied to normal trading income, it will put the UK rate at the very top of the European mainstream (above the German rate at 28.5% and on par with the French rate at 34%). Given pre-Budget concerns that carried interest might be made subject to full rates of income tax (plus NICs), the Government's proposals were greeted with relief by many in the private capital sector.

What's more, because the new rules will introduce an exclusive tax charge on carried interest (operating in much the same way as a 'flat tax' regime), it could ultimately be less complex than the current UK position and that of competitor EU jurisdictions. In addition, executives with carried interest in funds with primarily income returns, which are currently taxed at full income tax rates, may be better off under the new regime.

Having said that, the move to an exclusive trading income tax charge on all carried interest is likely to introduce significant technical complexity, particularly in relation to the position of non-resident executives (discussed further below) – an important issue given the global mobility of fund management executives. This has left many in the private capital sector ruing the fact that the Government did not choose the simpler option of keeping the current regime but bumping up the tax rate to 34.1%.

In this briefing, we explore the Government's proposals for the new trading income charge on carried interest, including its impact on non-residents.

Current position

Under the current UK tax rules, the starting position is that carried interest is taxed according to the nature of the underlying return out of which the carried interest is paid. Where (as is typical in private equity, venture and several other strategies) the fund and carried interest vehicles are both tax transparent limited partnerships, the underlying return is that received by the fund. Therefore, if the fund receives a capital payment, carried interest paid out of that return will also be capital.

However, this starting position is subject to a minimum capital gains tax charge (CGT) at 28% – so even if the underlying return were non-taxable (such as return of loan principal), carried interest deriving from it would be subject to tax at 28%. If the underlying return is taxable under ordinary principles, an offset mechanism should apply to prevent double taxation.

In addition, carried interest can be reclassified as trading income if it is "income-based carried interest" (IBCI). Carried interest is IBCI, broadly, unless the fund has a weighted-average holding period for its investments of at least 40 months (roughly 3 and a bit years). The IBCI rules are complex and contain specific alleviating provisions: for example, rules that allow later bolt-on acquisitions to be treated as having occurred when the original acquisition was made (such that the holding period of the bolt-on is extended). Importantly, the IBCI rules only apply to self-employed LLP members - employees are not in scope.

Non-residents

Currently, non-residents are not generally subject to UK tax on carried interest. This because they are typically outside the scope of CGT (and so not subject to tax on carried interest in the form of capital gains or within the minimum 28% charge) and most other investment returns in fund structures do not usually generate UK tax liabilities for non-residents (e.g. distributions, interest and returns of loan principle).

That being said, for non-residents who are both (i) non-employees and (ii) in receipt of IBCI, a trading income charge can arise on their carried interest, based on the extent to which they perform UK services. HMRC considers that this charge can potentially be relieved pursuant to a double tax treaty (DTT) between the UK and the relevant executive's jurisdiction of residence, provided that the relevant individual does not have a personal UK "permanent establishment".

Example showing the current UK tax treatment of carried interest derived from a number of sources

The new trading income regime

The trigger conditions for the new charge are expected to broadly replicate those for the current minimum CGT charge. This means that the current (wide) definition of "carried interest" will continue to apply and the key question will remain when does that carried interest "arise" to the executive? For these purposes, carried interest is treated as arising to an executive not just if it arises to them personally but also if it arises to persons (other than companies) connected with them or if they have the power to enjoy it. Helpfully, the rules will contain provisions allowing the time of "arising" to be pushed back if there are commercial carried interest deferral provisions in place.

What is "qualifying" carried interest?

Key to the new rules will be understanding what constitutes "qualifying" carried interest.

The Government has said that carried interest will not be "qualifying" if it is IBCI. The existing IBCI rules are expected to largely stay the same, subject to one important change: they will be extended to bring employees within their scope. This change has the potential to significantly impact funds that have found the IBCI difficult to apply and so have intentionally made their executives employees so as to fall outside their scope. This has been a common approach for credit funds, and, helpfully, the Government has indicated that there may be scope for amendments to the existing IBCI rules to ensure they work appropriately for that strategy. It is hoped that the Government will also take the opportunity to consider how the IBCI regime could be improved for other strategies and to cater for market developments that have occurred since it was introduced in 2016, for example, continuation funds (which, currently, typically reset the holding period clock).

In addition to the IBCI requirement, the Government is exploring introducing either or both of two further conditions for carried interest to be treated as "qualifying", variations of which can already be found in the French and Italian carried interest regimes.

A minimum co-investment requirement, such that executives would be required to co-invest a certain minimum amount into the funds they manage. In an important concession for industry, the Government has confirmed that any such condition would only apply on a team (rather than individual) basis, and the Government has expressly recognised the importance of not disproportionately impacting junior executives. However, as the Government recognises, this condition could be hard to design for a number of reasons. For example, catering for carried interest entitlements that vary over the fund's life.

A minimum holding period of the individual, such that, in addition to the fund's minimum average holding period, individual executives would have to hold their right to carried interest for a minimum time period before receiving carried interest returns. In this regard, the Government notes that the responses it received to the call for evidence suggested that 7 years was a typical individual holding period. If this were adopted as the minimum period, it would be significantly more onerous than the five year period in the French and Italian rules.

Of the two conditions, the latter may be the Government's preference as it notes the "practical challenges associated with implementing a co-investment condition". However, it would be a mistake to see a minimum holding period requirement as a straightforward option and the Government has provided little detail on how it could work. Important issues that need to be addressed include:

will the holding period end when the carried interest is allocated (either at fund or carried interest partnership level) or will it be when the executive receives the cash? The former approach is better tied to the fund performance but is more complex and may conflict with the IBCI regime if both sets of rules are linked to fund level disposals. The latter approach is similar to the French rules and may lead (as it does there) to carried interest simply being tied-up (for no obvious benefit) in escrow mechanisms.
how will it cope with the complexities and variations in fund structures? For example, how would it apply to "deal-by-deal" carried interest arrangements, US tax distributions provisions and leavers/joiners.

No decision has been made on the conditions, but, if either were introduced, it would represent a significant tightening of the requirements to access preferential carried interest tax treatment.

International aspects

This is perhaps the technical area that has attracted most attention (and criticism).

Extent of UK charge on non-residents

In a broadening of the UK's taxing rights, the new trading income charge will apply to non-residents to the extent (broadly) that they receive carried interest that relates to services performed in the UK.

This approach is not entirely novel, and is the position that applies to carried interest that is taxed as IBCI under current rules. We expect that HMRC will consider that their view (discussed above) that DTT relief is potentially available will equally apply to the new trading income charge. However, the current IBCI charge for non-residents comes up rarely in practice for many private capital management businesses (because most carried interest is structured to fall outside the IBCI rules), whereas the new charge potentially applies to all carried interest. This will increase the focus on the following technical questions.

a) How to determine the extent to which an individual performs relevant services in the UK?

It is expected that HMRC will want to look at the entire period over which the carried interest was earned rather than the tax year in which it happens to arise. If that is the case, executives who permanently leave the UK would be liable to UK tax on carried interest they later receive when non-resident (even where they leave the UK before the new carried interest regime comes into force and regardless of whether they performed any UK duties in the year that the carried interest pays out).

Whilst the Government's stated position is that it does not generally see a case for transitional provision (see below), there is an obvious unfairness in the new approach for those that left the UK before the Autumn Budget. It also remains to be seen whether the Government might be persuaded to introduce a cap on this liability 'tail', to prevent the UK carried interest rules from applying on a potentially indefinite basis.

b) Will DTT relief be available and, if so, what are the mechanics for claiming it?

It is not entirely clear that HMRC's view that DTT relief is available for amounts that the UK treats as trading income (whatever the nature of the underlying return) is technically correct. Even if it is, improved guidance will be needed on what constitutes a personal "permanent establishment". This will be especially important for executives who regularly come to the UK but only for short periods (e.g. a couple of days a month). HMRC's guidance on the current rules appears to be more focused on the position of executives who come to the UK less frequently (referring to people who come "very rarely" or "occasionally"), and even then is not entirely reassuring, indicating that it would not expect them to be within the charge to tax but this would have to be considered carefully on the specific facts.

An additional issue is the practical complication of the need for non-residents (who do not have a UK permanent establishment) to file a DTT relief claim with HMRC.

A solution may be to build an exclusion into the domestic charge for individuals who do not have a UK "permanent establishment", such that a DTT relief claim is unnecessary. This would also allow HMRC to clearly define "permanent establishment" solely for the purposes of the new rules, thereby side-stepping the need to use the DTT international meaning of the term and allowing a higher threshold of UK presence to be required.

UK residents – international aspects of the new regime

For UK residents, a key issue will be the position of carried interest returns deriving from a non-UK source. The starting UK position will be that those returns are subject to a domestic trading income charge - but what happens if the local jurisdiction also claims taxing rights? In that situation, it is unclear whether, and to what extent, relief will be available to prevent double taxation. For example, what will happen if a UK executive receives carried interest in the form of foreign dividend income that has been subject to local withholding tax? From a policy perspective, our view is that the executive ought to get a credit against their UK tax liability for foreign withholding under an applicable double tax treaty (or failing that, under the UK's domestic rules), but the technical position is not clear cut and will likely depend on the specific facts and circumstances.

Another area that will need careful thought is the position of UK residents who are also subject to US tax as US citizens. The issue here being that those individuals will want to ensure that they get a credit against their US tax liability for any UK tax on carried interest, notwithstanding the fact that the UK will see the carried interest as deemed trading income.

Non-doms

The Government has confirmed that qualifying carried interest that relates to non-UK services performed by an executive should be treated as foreign income and gains (FIG) for the purposes of the rules that will replace the current non-dom regime (from April 2025). Under the replacement regime, broadly, there will be 100% tax relief on FIG for individuals in their first 4 years of UK tax residence, provided that such persons have not been UK tax resident in any of the 10 consecutive years prior to their arrival. For more detail on non-dom reform please see our Autumn Budget briefing.

Non-qualifying carried interest relating to non-UK services will, however, have much more limited access to the FIG regime. Broadly, it will only apply to the extent it relates to services performed outside the UK in tax years before the relevant executive's first tax year of UK residence.

Example showing the UK tax treatment of carried interest derived from a number of sources updated to reflect the position from 6 April 2026

Transitional rules

In an unwelcome (but not unsurprising) announcement, the Government confirmed that it does not consider that there is any case to exclude existing fund structures from the new regime once it takes effect in April 2026 or to provide any other transitional provisions, unless either of the additional conditions for "qualifying" carried interest status is introduced. The Government has specifically asked for views in relation to transitional provisions for any minimum co-investment requirement. However, it has said that it does not think such provisions are necessary for any minimum carried interest holding period requirement (although it notes that there may be specific fact patterns to consider before finally determining the point).

Next steps

The Government has established a working group with stakeholders to consider the detailed design of the regime and is running a public consultation in relation to the possible additional conditions for "qualifying" carried interest status which closes on 31 January 2025. Members of the Travers Smith Tax Department are on the working group and we will be responding to the consultation, both through our membership of industry bodies and on our own behalf.

If you have any questions, please do get in touch.

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