Legal briefing | 25 Jul 2025 |

New UK carried interest tax regime: draft rules published

On Monday, the government published the much anticipated first draft of the legislation implementing the UK's new carried interest tax regime which is coming into force from 6 April next year. We have known for some time the key features of the regime, under which all carried interest will be taxed as trading income (with a bespoke effective rate of around 34.1% being available for so-called "qualifying carried interest"), but now we have a good idea of the detail.

        
            Key takeaways
        
No big surprises - the main features of the regime are in line with the government's previous policy announcements.
As expected, the only requirement that carried interest will have to meet to be "qualifying" is that it is not (what is currently called) income-based carried interest (IBCI). Although the IBCI regime has been expanded to encompass employees, it has been helpfully updated to make it easier for carried interest not to be IBCI, in particular, in relation to private credit, fund of funds and secondary strategies.
The expected limitations to the new tax charge for non-resident executives are to be introduced, but we now have clarity on what counts as a "UK workday" – it's a day on which an executive spends more than three hours performing investment management services in the UK. Notably, those services do not have to relate to the fund from which the carried interest derives.
The government has not excluded the new carried interest trading income charge from the payment on account (POA) rules.
The disguised investment management fee (DIMF) anti-avoidance rules will be extended to catch sums received from corporate funds.

Webinar

We will be hosting a special webinar on the new regime in which we will provide an overview of draft legislation and explain what the new rules mean for private capital businesses and executives.

Date: Wednesday 30th July 2025

Time: 1pm - 2pm

RSVP

Overview of the new regime

Although the regime is new, it borrows some of its machinery from the current rules, so these aspects will have a familiar feel for many private capital businesses and their advisors.

Broadly speaking, the new charge applies where carried interest arises to a fund manager from an investment fund.

Carried interest – this is similar to the current broad definition which typically catches anything that is commercially considered to be carried interest. As is currently the case it also catches amounts received for the disposal, variation, loss or cancellation of a right to carried interest. In addition, "tax distributions" are specifically brought within the definition for the first time, however the proposed drafting will need some tidying up to catch U.S. model distributions.
Fund manager – the already broad definition is increased to specifically pick up persons who perform investment advisory services and any activity that is incidental or ancillary to investment management/advisory services.
Investment fund – the already broad definition has been expanded to bring corporate funds within the scope of the rules.
Arises to the individual – this is very similar to the current definition, so, as well as carried interest that actually arises to the individual fund manager, it also includes carried interest that arises to (i) persons (other than a company) connected with them or (ii) any person in circumstances where the individual has the "power to enjoy" it. Commercial deferral arrangements can delay the time of "arising" until the deferral period ends.

If the conditions for a charge are met, the carried interest (less any money paid for the right to the carried interest) is taxed as trading profit at rates of up to 47% (45% income tax plus 2% national insurance contributions), regardless of the underlying nature of the return. However, provided the carried interest is "qualifying" (see "qualifying carried interest" below) only 72.5% of it comes within the charge, giving an effective tax rate of around 34.1% (47% x 72.5%).

Non-residents are within the new trading income charge, broadly, to the extent their carried interest derives from investment management services they perform in the UK. However, three important limitations on the domestic charge apply to "qualifying carried interest", but, if they are not available, relief may be available (for any carried interest) under a double tax treaty. For executives who become UK resident, the new inpatriate regime (which replaced the "non-dom" regime in April) potentially applies to their carried interest. For more detail, see "international aspects" below.

Under the draft legislation, the trading income charge is not quite as exclusive as the government had originally indicated, in that employment tax charges on carry returns take priority (although, in practice, these rarely arise, especially where 431 tax elections have been made). Further, the legislation contains provisions designed to prevent double UK taxation (for example where the value of carried interest is subject to employment taxes on award or somebody else is taxed in relation to the executive's carried interest). However, this involves making a claim for relief (rather than being automatic) and the provisions are generally narrower in scope than those under the existing carried interest regime, potentially resulting in gaps in the availability of double tax relief. We expect that the application of these double tax provisions will be an area of focus for stakeholders during the consultation process.

As carried interest will be taxed as trading profit, it will fall within the UK's POA rules, under which self-employed individuals are required to make advanced payments on account of their expected future tax liability. This is likely to give rise to significant cash flow issues for executives as, although the POA rules work well for regular income streams, carried interest tends to be lumpy and unpredictable. There has been much industry lobbying on this point, and it is hoped that the government softens its position in the final legislation.

Qualifying carried interest

The question of whether carried interest is "qualifying" is important because:

only 72.5% of it falls within the new charge;
for non-residents, certain limitations to the tax charge apply to it; and
for new UK residents, the UK's new inpatriate regime applies more generously to it.

The rules for determining whether carried interest is qualifying are contained in a rebranded and improved version of the IBCI regime. Accordingly, carried interest will be "qualifying" provided it derives from a fund that has a weighted-average holding period (AHP) for its assets of at least 40 months. Where a fund has an AHP of more than 36 months but less than 40 months a proportion of the carried interest will be qualifying.

Under the current IBCI rules, there is an exclusion for carried interest held by employees. This means that where there are concerns that a fund's carried interest will be IBCI, it has been common to ensure that team members are employees (rather than just LLP members). Importantly, the employee exclusion is not in the new regime – such that a greater range of funds and their executives will need to consider the AHP rules.

Calculating AHPs

The starting position is that every injection of cash into an investment is treated separately - with its own holding period that feeds into the overall AHP. That means, without special rules, later bolt-on acquisitions would reduce a fund's AHP, as would early part disposals. The legislation addresses this by having a series of bespoke rules (often referred to as "T1/T2" rules) for different investment strategies which seek to ensure that holding periods are measured in a commercially realistic way.

As expected, most of the AHP calculation mechanics contained in the IBCI regime has been retained in the new regime. Helpfully, some improvements have been made, including:

transfers between different investment schemes in the same overall fund will be ignored, such that their holding periods are treated as a single one (e.g. transfers between two stapled parallel fund vehicles);
the rules that allow unwanted short-term investments to be ignored have been made easier to access (e.g. where a fund acquires a bundle of investments and then disposes of some unwanted ones shortly after acquisition); and
the conditions for applying T1/T2 rules for venture capital funds and funds that take significant (at least 20%) equity stakes in unlisted trading companies have been relaxed, such that (broadly) it is no longer necessary for the fund to have the right to appoint a director of investee companies.

However, the key AHP changes relate to (i) credit funds and (ii) funds of funds and secondary funds.

Credit funds

Credit funds are particularly harshly treated under the current IBCI rules – it is difficult for credit funds to give rise to anything other than IBCI (non-qualifying profits under this new regime). This reflects HMRC's suspicion, when the rules were originally drafted, that they were more likely than other strategies to be carrying out a trade (akin to banking) rather than investing. Fortunately, HMRC is now far more comfortable that credit funds are pursuing a genuine investment activity, and this has led to the new rules including a helpful suite of T1/T2 provisions.

For the purposes of the new regime, the "credit fund" definition should be broad enough to encompass most funds that consider themselves to be credit funds. For such funds, the T1/T2 rules apply to stretch holding periods (including for later associated equity investments) where a "significant debt investment" has been made – broadly, a debt investment of at least £1m or at least 5% of the total amount raised from external investors. Helpfully, a debt investment is treated as made once a facility is unconditionally committed (even if no advance has yet been made).

Other welcome features of the credit fund rules include:

the unexpected prepayment of a loan before the 40-month holding period has elapsed, can (provided certain condition are met) effectively be treated as generating a 40-month holding period; and
provisions designed to prevent holding periods being treated as shortened by common transactions which are not, from a commercial perspective, considered to be disposals of investments. These include transactions undertaken for commercial purposes before and after which the fund is exposed to substantially the same risks and rewards in respect of the debtor group. The full intended scope of this provision is not entirely clear. We expect HMRC intends it to be read broadly, so encompassing a wide variety of debt restructurings such as "debt for equity swaps" and the acquisition of secured assets from defaulting borrowers, but prompt HMRC confirmation of this would be very welcome.

Secondary funds and funds of funds

There are currently separate T1/T2 rules for funds of funds and for secondary funds, but they do not work very well. Under the new regime, there will be a single set of T1/T2 rules which will apply to both strategies. Most of the changes from the previous (two sets of) rules, make the T1/T2 rules easier to access. However, unexpectedly, an additional gateway condition has been inserted which requires the fund to be a "qualifying fund". This concept is borrowed from the UK's qualifying asset holding company regime and can be difficult to apply. In addition, the most popular way of attaining "qualifying fund" status requires certain wording to be included in the fund documents. Whilst it is common for UK funds to include this wording, it is much less likely that non-UK funds will have done so. This a particular concern for existing structures, and it is hoped that the government either removes the "qualifying fund" requirement or includes grandfathering provisions.

What about carried interest received early in a fund's life?

The AHP is determined at the time the carried interest arises, so amounts received early in a fund's life are potentially problematic. To address this issue, it is possible to make a claim for conditional exemption from non-qualifying status. Essentially, this can be done if it is reasonable to expect that, at the time that the carried interest arises, ultimately the fund will have an AHP of at least 40 months. There are two key points to note here:

If it ultimately transpires that the fund's AHP is less than 40 months, then the executive will need to make good the underpaid tax (plus interest).
The exemption must be claimed in an executive's tax return for the tax year in which the carried interest arises.

International aspects

To what extent does the charge apply to non-residents?

An important consequence of treating carried interest as trading profit is that the UK looks to assert greater taxing rights over non-residents than it would if the return were capital.

Under the new regime, non-residents are subject to tax based on their number of "UK workdays". These are days on which an executive spends more than three hours performing any investment management services. Importantly, the services do not need to relate to the fund from which the carried interest derives.

Essentially, you take the total number of "applicable workdays" (i.e. days on which the executive performs investment management services in relation to any fund) in the "relevant period", and then work out the proportion of those that are UK workdays. So, if half the workdays in the period are UK workdays, half of the non-resident executive's carried interest will be within the charge (subject to the limitations and double tax relief discussed below).

The "relevant period" definition is not straightforward. Broadly, it is the period beginning on the day when it was first contemplated that carried interest might arise from the fund that ultimately pays it out and ending on the last day when the carried interest arises to the individual from that fund in the relevant tax year (so the tax year for which you are calculating the carried interest trading profits). It is unclear, from the legislation, whether the relevant period can start before the fund is established.

In a helpful relaxation of the regime for non-residents, "UK workdays" are ignored if:

they are prior to 30 October 2024. This effectively operates as a form of grandfathering;
they are in a tax year in which the non-resident has fewer than 60 UK workdays. This is designed to ensure that short-term business visitors are protected from UK taxation; or
they occur in a period since which at least three tax years have passed when the non-resident has had fewer than 60 UK workdays. This effectively means there is a three-year limit to any "tail" liability for an executive who becomes non-UK resident (provided thereafter they have fewer than 60 UK workdays per tax year).

However, these relaxations only apply to qualifying carried interest. This is potentially problematic because at the time the executive is considering whether to provide UK services they may well not know whether the fund will have a 40-month AHP. This uncertainty may discourage non-resident executives from coming to the UK even for short periods. In addition, having to assess whether the 40-month condition is likely to be met will be difficult in practice for firms with little UK infrastructure.

Importantly, even if a non-resident is within the UK's domestic charge, HMRC considers that relief is potentially available under a double taxation treaty between the UK and the non-resident's country of tax residence. This should be the case provided the non-resident does not have a personal "permanent establishment" in the UK. However, it is far from clear what level of presence will constitute such an establishment. Unfortunately, the draft legislation does not shed any further light on this issue (as it is a question of treaty interpretation), so it will be important that HMRC's guidance (when published) provides clarity.

UK's inpatriate regime

In April, the UK introduced its new inpatriate regime (as a replacement to the "non-dom" regime) under which an individual can choose not to be subject to tax on their foreign income and gains (FIG) during their first four years of UK tax residence (provided they have not been UK resident in any of the 10 consecutive tax years prior to their arrival).

Qualifying carried interest will be FIG for the purposes of the inpatriate regime to the extent it is treated as arising outside the UK. Broadly, this is calculated based on the proportion of non-UK workdays in the "relevant period" (see above).

The position is different for non-qualifying carried interest. This will be FIG to the extent it is treated as arising outside the UK - but only in relation to tax years before the executive became UK tax resident. Broadly, this is calculated based on the proportion of non-UK workdays (in pre-arrival tax years only) in the "relevant period" (see above).

Comment

The new regime is a significant departure from the current position, despite the fact that the legislation uses or adapts several existing tax concepts. Further, whilst the main features of the regime are in line with the government's previous policy announcement, we have already identified several issues with the draft legislation and expect that more will become apparent as private capital businesses and their advisors seek to apply it to their particular circumstances. It should be emphasised that the legislation is still in draft form and open for consultation until 15 September. HMRC has shown itself prepared to take on board stakeholder feedback, so hopefully many of the technical wrinkles (if not policy concerns) will be ironed out before the legislation makes the statute book.

The "workday" based apportionment for determining the extent to which the carried interest trade is carried out in the UK and abroad is entirely new and can lead to surprising results. This is primarily because for apportionment purposes all investment managements services performed by the executive are brought into account – even if they do not relate to the fund which is paying out the relevant carried interest. Therefore, the extent to which a non-resident is liable for UK tax on carried interest received from one fund may depend on the amount of work they carry out in the UK for a different fund (potentially for a different private capital business).

Whilst ideally the government would have used the introduction of the new regime as an opportunity to fundamentally simplify the AHP calculation, the technical changes it is making are overall very welcome. However, the focus in the T1/T2 rules on particular strategies means that it is often difficult for multi-strategy funds to benefit from them – something which will be increasingly problematic with the removal of the employee exemption. Similarly, it is disappointing that no provision is made to facilitate continuation vehicles – a much more significant aspect of the private fund landscape since the IBCI rules were introduced in 2016.

An important change that had not been previously announced is that amendments will be made to the DIMF rules. In particular, the wide definition of "investment scheme" used in the carried interest regime will also be included in the DIMF rules, thereby bringing a much wider range of corporate funds within their scope. The fact that most corporate funds were not within the DIMF rules has always been anomalous, but it is surprising that there has been no consultation on the reversal of this position.

Read Elena Rowlands Profile