The Budget 2026 : Private Capital

In a surprise move, the Chancellor announced a fundamental reform of how foreign sovereigns, such as heads of state, sovereign wealth funds and overseas public pension schemes, are treated for UK tax purposes.

Although the details are yet to be finalised and are being consulted on, the key planks of the new regime are clear. From 1 January 2029, sovereigns will generally be taxed on income and gains in the same way as other non-residents. This means that they will be subject to tax on income profits from UK land, and, in limited circumstances, UK trades. In addition, they will be within the scope of non-resident capital gains tax (NRCGT), which applies to disposals of UK land or UK property rich vehicles.

There are some exemptions. These only apply if the sovereign falls within the new concept of a person with "sovereign tax status" (an STS). This will be a new statutory categorisation, and a formal application to HMRC will be required. The list of STSs is generous, and includes, foreign states, sovereign wealth funds and, importantly, State-operated Overseas Pension Funds (SOPFs).

STS will benefit from an exemption from tax on UK source interest. However, this is not particularly significant as it is already fairly straightforward to structure financing arrangements so that non-resident lenders are not subject to tax on resultant UK source interest. More interestingly, SOPFs will benefit from an exemption from NRCGT, and new reliefs will be available to STSs which have UK-based in-house investment management teams.

In addition, under the plans, STSs will, subject to some exceptions, continue to be qualifying (i.e."good") institutional investors (QIIs) for the purposes of the various tax regimes that confer tax privileges on certain non-sovereign entities that have a sufficient proportion of investors who are QIIs.

Further, in an effort to balance effective taxation of returns from UK real estate with support for sovereign capital in the UK real estate market, the government is planning to introduce for STSs "bespoke access to a REIT structure which will enable them to hold a controlling interest in a REIT through a UK company while benefiting from a 15% tax rate on property income distributions."

Sovereigns investing in UK real estate will need to review their arrangements, as will those receiving, or potentially receiving, UK trading income. This could include where they hold interests in trading LLPs, for example as a result of a "GP stake" deal. In addition, the position of management fee rebates should be considered.

The regime will have effect from 1 January 2029, but some helpful transitional provisions apply. The design of the new regime is now the subject of consultation, which will be followed by a further, technical, consultation on draft legislation ahead of final rules being included in Finance Bill 2027-28.

In June 2026, the government launched a consultation on accelerating the payment of income tax self-assessment (ITSA) liabilities, with the stated aim of bringing tax payments closer to the point at which income is earned. The proposals have particular significance for private capital executives given that carried interest has been within the income tax regime since 6 April 2026.

The consultation proposed two main reforms, both intended to take effect from April 2029:

• For ITSA taxpayers with sufficient PAYE income, mandatory collection of ITSA payments through PAYE each pay period; and
• For the wider ITSA population (those without PAYE income), accelerated payments on account, potentially on a monthly or quarterly basis.

What the government has decided

The government has confirmed it is pressing ahead with the reforms from April 2029.

However, rather than requiring eligible taxpayers to make ITSA payments through PAYE, the government has decided that automated in-year payments (for example through Direct Debit) will be the default approach for the ITSA population as a whole. Taxpayers with sufficient PAYE income will have the option to elect to make their ITSA payments through PAYE, but this will no longer be mandatory.

What this means for private capital executives

The shift away from mandatory PAYE collection is a welcome development for private capital executives.

The prospect of carried interest receipts, which are by their nature irregular and unpredictable, being swept up into a rigid PAYE deduction mechanism each pay period had the potential to create serious and largely unmanageable cashflow difficulties. The flexibility inherent in a Direct Debit based model, combined with the ability to update forecasts in response to changes in circumstances, is a more workable proposition for executives whose income profile does not follow a regular pattern.

That said, the position remains far from settled, and the following points are worth noting:

• Carried interest is still not specifically addressed

Despite the private capital sector having raised the particular difficulties posed by carried interest returns throughout the consultation process, both in the context of the original carried interest regime consultation and in responses to the timely payments consultation, the government's response does not specifically address carried interest.

The characteristics of carried interest (large one-off receipts, timing driven by deal activity, no reliable year-on-year comparator) sit awkwardly with any regime that requires in-year payments based on prior year returns.

• The central concern over cashflow issues remains

Even with a Direct Debit default, an executive who receives a significant carried interest distribution late in a tax year may find that they have been making in-year payments based on a prior year return that does not accurately reflect that receipt, resulting either in a large balancing payment or, conversely, having made substantial overpayments throughout the year.

The ability to update forecasts in real time will be critical, and the terms on which adjustments can be made, in particular, whether penalties or interest will apply where estimates prove inaccurate, have yet to be finalised.

• Key design questions remain outstanding

Several critical design questions remain open. The government has confirmed it will continue working with stakeholders and will set out further detail next year on:

• Payment frequency and timing;
• Safeguards and flexibilities for taxpayers facing financial difficulty;
• The compliance framework (including penalties and interest); and
• The mechanics of the transition.

The answers to these questions will determine how manageable the new regime is in practice.

We will continue to monitor developments and will provide further updates as the detailed design of the new regime emerges.

The Government has indicated that it will seek to protect the UK's private capital industry in any changes that it makes to the UK's distributions framework.

HMRC launched a consultation in June 2026 on proposals to (amongst other things) reduce the situations where UK resident individual shareholders can obtain capital rather than income treatment on returns of value from non-UK tax resident companies.

In the consultation, the private capital industry raised serious concerns about the consequences these proposals could have on the ability of non-UK fund structures to efficiently repatriate capital gains from investment holding structures. Two particular groups could be hard hit by the measures:

• First, UK tax resident executive co-investors, who could see a rise in the effective tax rate on their co-investment returns (from 24% to up to 39.35%), undermining the UK's position as a hub for asset management; and
  
  
• Second, high-net worth individual investors (an increasing constituency in private capital fund structure) who could similarly see a rise in their effective tax rate on fund returns, cutting across government policy to increase investment allocations to private capital.

Industry will breathe a sigh of relief that, in its response to the consultation, HMRC has confirmed that investment professionals' co-investment returns and "genuine" investment returns from fund structures will not be affected by the proposed reforms and should continue to receive capital treatment in situations where that is available under current rules. No details have yet been released on how these objectives will be achieved through legislation and so industry will want to continue to pay close attention to these developments.

HMRC will launch a technical consultation on the number rules in 2027 (including draft legislation), with the changes taking effect from 2028.

For the full briefing on the Government's response to its consultation on the UK's distributions framework, see our Budget 2026 analysis on Business Taxes.

The Government intends to introduce a tax credit mechanism to provide double tax relief for UK resident individuals investing through "reverse hybrid" entities, such as US LLCs.

Broadly, a reverse hybrid entity is one that is treated as transparent (so "look through") for tax purposes in its jurisdiction of establishment but opaque in a jurisdiction where one of its investors is resident.

Reverse hybrids can create double taxation for their investors. An important example of this in the UK is the treatment of US limited liability companies (LLCs) – these are typically treated as tax transparent in the US, but HMRC considers that they are normally opaque. This means that, in the US, UK resident members are subject to tax on their share of the profits of the LLC as they arise, but not on distributions of those (post-US tax) profits. However, in the UK, those members are not taxed on the profits as they arise in the LLC but are taxed on distributions of those (post-US tax) profits. This mismatch can result in UK resident members suffering tax in both the US and the UK on income received from LLCs, with no ability to claim double tax relief under the UK/US Double Tax Treaty or under domestic relief rules.

On 10 June 2026, HMRC published a consultation on proposals to address this issue. The primary proposal was to introduce a measure under which reverse hybrids would be treated as transparent from the perspective of their members who are UK tax resident individuals, but alternative ideas were also put forward, including the provision of relief by credit or deduction.

HMRC has now published its response to the consultation.

The key points are:

• HMRC has dropped its proposal to treat reverse hybrids as tax transparent, conceding it would be technically complicated to implement and would integrate poorly into the wider tax system.
• HMRC is proposing instead to proceed with an elective tax credit mechanism, where certain entities (such as LLCs) would be identified by statute and treated as opaque and individual investors in them would be entitled to receive a credit for eligible foreign taxes paid by them personally on the entity's profits. The credit would be applied to reduce the UK tax the investor would otherwise suffer on the distribution from the reverse hybrid.

Reverse hybrids, and particularly US LLCs, are a common feature of private capital structures and so HMRC's decision to adopt a smoother and simpler mechanism for double tax relief for UK investors is a welcome move.

However, key details on the credit system's operation remain unclear (including, for example, how the eligible foreign tax rate will be calculated where a reverse hybrid has a range of sources of income and gains).

HMRC will consult further on the technical aspects of the proposed credit system where the key technical issues will hopefully be ironed out. HMRC is looking to introduce the new form of credit in 2028.

The government is making a technical change to how the rules on attributing capital gains that arise to non-UK resident close companies apply to interest holders of protected cell companies (PCCs).

The current rules state that capital gains arising to a non-UK resident company that qualifies as closely held should be attributed to any "participator" in that company who holds an interest of more than 25% in it. The '+25%' threshold test is currently measured across the company as a whole. However, a PCC is a company whose assets and liabilities are split into a number of separate and distinct cells. Therefore, under the current drafting of the rules, a shareholder in a PCC could satisfy the +25% threshold test in one cell of the PCC but not across the PCC as a whole and therefore fall outside the application of these rules.

To address what it perceives to be an unintended gap in the law, the government is proposing to amend the application of the +25% threshold test so that it can apply at the level of an individual cell within a PCC, as well as at the level of the PCC as a whole. One consequence of this technical change is that UK resident individuals will no longer be able to use non-UK resident PCCs to 'block' UK capital gains tax.

PCC are commonly used in umbrella and multi-class private fund structures as well as for family investment vehicles. Operators of these vehicles will therefore need to reassess the application of these anti-avoidance rules in light of the proposed changes.

The changes are due to take effect from 28 October 2026.