Taxation of Carried Interest after April 2025

The taxation of carried interest in the UK is set to undergo significant changes in the coming years, with implications for fund managers and the private equity industry as a whole. These changes will be implemented in two phases, starting from April 2025 and then further evolving in April 2026.

Changes from April 2025

From 6 April 2025, the capital gains tax (CGT) rate on carried interest will increase from the current 28% to 32%. This interim measure is designed to bridge the gap until more comprehensive reforms take effect in April 2026. The increase aims to align the tax treatment of carried interest more closely with other forms of income, ensuring a fairer and more stable tax regime.

For fund managers, this change will result in higher tax bills in the short term. For example:

• A fund manager earning £5 million in carried interest will see their tax liability increase from £1,400,000 (28% of £5 million) to £1,600,000 (32% of £5 million)[2].
• For a fund manager earning £500,000 in carried interest, the tax liability will rise from £140,000 to £160,000[2].

It's important to note that during this period, the character of the underlying returns (capital gains, interest, or dividends) will still need to be considered when determining the applicable tax rate.

Fundamental Changes from April 2026

Starting from 6 April 2026, the UK government plans to implement a more comprehensive reform of the carried interest taxation regime. The key changes include:

1. Reclassification as Trading Profits: Carried interest will be taxed as trading profits under the Income Tax framework, rather than being subject to CGT.
2. New Tax Rates:
   • For "qualifying carried interest", a 72.5% multiplier will be applied, resulting in an effective tax rate of 34.08% (including National Insurance Contributions) for additional rate taxpayers.
   • Non-qualifying carried interest will be subject to full income tax rates of up to 45% plus 2% NICs.
3. Qualifying Carried Interest: The government will introduce modified Income-Based Carried Interest (IBCI) rules to determine what constitutes qualifying carried interest. Currently if the fund average holding period exceeds 40 months, Carried Interest can be assumed it's not ICBI and taxed at a lower rate. The government is looking at additional conditions such as satisfying a minimum GP commitment and/or “lock up” test for the Carried Interest to be "qualifying".
4. Simplification: The nature of the underlying returns (gains, interest, dividends) will no longer need to be considered when applying the relevant taxation rate. Also, the new ICBI rules are to apply to all individuals receiving carried interest, whether they are employees, LLP members or consultants which is not the case today.

Implications when Leaving the UK

The reclassification of carried interest as income rather than capital gains from April 2026 will have significant implications for fund managers considering leaving the UK:

1. Timing of Realisation: Fund managers may need to carefully consider the timing of realising their carried interest. Realising it before leaving the UK could result in higher tax liabilities, while deferring realisation until after departure might offer tax advantages, depending on the tax regime of the new country of residence.
2. Double Taxation Agreements: The change in classification may affect how carried interest is treated under double taxation agreements between the UK and other countries. This could impact the overall tax position of fund managers who relocate internationally.
3. Non-UK Residents: For non-UK residents, carried interest will be subject to income tax on the portion related to services performed in the UK, mirroring the approach taken under Double Taxation Relief (Miscellaneous Provisions) rules.
4. Exit Charges: Under the new regime, all income (including non IBCI) will be treated as trading income which means that individuals leaving the UK will be subject to exit charges on unrealised gains. That's in contrast with today's situation where leaving the UK allows you to avoid tax on non IBCI Carried Interest received after you have left the country.

These changes represent a significant shift in the UK's approach to taxing carried interest. Fund managers and private equity professionals should carefully consider the implications of these new rules, especially when contemplating international moves or structuring their compensation arrangements. As the implementation date approaches, it will be crucial to seek professional advice to navigate these complex changes and optimise tax planning strategies.