UK Carried Interest Taxation

1. Tax treatment

• Carried interest will be treated as trading income, not investment return and subject to income tax and Class 4 NIC.
• “Qualifying carried interest” will have a 72.5% multiplier applied to it, resulting in an effective tax rate of 34.075% on carried interest.

2. Additional qualifying conditions

The government has confirmed that it will not impose the following additional qualifying conditions in respect of carried interest.

• Minimum team-level co-investment.
• Minimum holding period of carried interest.

3. Income-based carried interest (IBCI) / average holding period (AHP)

• The government has confirmed that IBCI (now being referred to as AHP) rules will be retained but refined to provide fairer treatment to all investment strategies.
• This will be of particular benefit to credit funds and fund of funds.

4. Employment-related securities (ERS)

• The previous exemption to the IBCI rules that applied to carried interest that was subject to the ERS regime will be removed.

5. Non-resident taxation

As carried interest will be treated as UK trading income it will remain subject to UK tax even if an individual is a non-UK tax resident. However, the government have now refined the rules to state UK tax will only apply if all the following apply:

• UK services performed in the previous three tax years
• UK services were performed in a tax year when the individual was a UK tax resident or met the UK workday threshold (60 UK workdays in a tax year)
• where there is an applicable double tax agreement (DTA), the UK services are attributable to a UK permanent establishment of the individual.

It has been confirmed that carried interest subject to UK tax will be split between UK and non-UK services. This will be based on the number of UK and non-UK workdays, using a time-based apportionment method.

All UK services prior to 30 October 2024 are to be treated as non-UK services.

6. Payments on account

• Carried interest will form part of the payment on accounts regime.
• Thus 50% of the prior year’s tax on carried interest will be required to be paid each January and July unless reduction claims are made.

Key considerations

• With the introduction of a flat rate of tax being applied to carried interest, the use of preference shares instead of loan notes will no longer provide a tax benefit for carried interest holders. Therefore, funds should consider using loan notes in deal structures due to their greater security and easier ability to refinance. Preference shares will likely still be beneficial for management teams from a tax perspective.
• Monitoring compliance with the IBCI rules will be of even greater importance and best practice would be for funds to review this on a quarterly basis.
• Following the removal of the IBCI exemption for ERS, investment houses previously structured as limited companies may consider converting to LLPs, particularly in light of employer NIC savings. However, any restructuring should be carefully assessed to ensure compliance with the salaried member legislation.
• Individuals becoming non-UK residents will need to be wary of UK rules and monitor days returning to the UK to ensure they are not subject to UK tax on carried interest. 
• Upon publication of legislation a careful review of key terms such as ‘UK workday’ and ‘relevant period’ will need to be considered to ensure no nasty surprises.
• For those non-UK residents subject to UK tax on carried interest, a review of whether their ‘home’ jurisdiction will allow a credit for UK taxes will need to be considered to ensure no double taxation arises.
• Due to carried interest forming part of the payment on account regime, cashflow management and modelling will become extremely important.
• Care should also be taken when reducing payments on account as any excess reduction will be subject to late payment interest, currently at 8.25%.

Next steps

The government has confirmed that draft legislation will be published prior to the summer 2025 recess and that they will work actively with stakeholders before finalising legislation.

Now that further clarity has been provided on the rules, investment managers should consider:

• reviewing existing fund structures in terms of IBCI compliance but also deal structures
• modelling tax outcomes using the new rates of carried interest and where possible crystalise transactions prior to 5 April 2026 if a better tax outcome would arise
• prepare for revised record-keeping and reporting, especially around workday tracking.

If you would like to discuss the impact of the changes, please contact Alex Conway or your usual Crowe contact.

You can also find out more information on the increased reporting requirements in relation to carried interest that HMRC are expecting to receive from the 2024/25 tax year here.