The UK's carried interest tax regime

What is "carried interest"?

For the purposes of the regime, carried interest is essentially a sum that an executive receives that is conditional on there being, and is substantially variable by reference to, profits of an "investment scheme" (see below). It is further required that returns to investors are also determined by reference to those profits and that there is a significant risk that the carried interest will not arise.  Helpfully, the definition applies to both "fund as a whole" and "deal by deal" carried interest models (in the case of the latter, only the profits relating to the particular investment are relevant).

The requirements set out above are deemed to be met in relation to carried interest that only arises after investors have received back all their contributions (or, for a "deal by deal model" those relating to the relevant investment) plus a return equating to 6% per annum.

The above definition of carried interest will typically catch any sum that is commercially considered to be carried interest. However, the legislation goes further and treats the following items as carried interest:

a) amounts received for the disposal, variation, loss or cancellation of a right to carried interest; and

b) tax distributions. Essentially, these are sums (i) that can only arise if tax (including non-UK tax) becomes, or is expected to become, payable as a result of the executive's entitlement to carried interest, but (ii) which are then deducted from that entitlement.  

Co-investment is expressly excluded from being carried interest.

What is an "investment scheme"?

An investment scheme is anything that is either a collective investment scheme (CIS) or AIF for UK regulatory purposes. This, already wide, definition is expanded by anti-avoidance provisions designed to catch arrangements under which, broadly, either:

a) an external investor can participate in a CIS's or AIF's investments without investing in the fund itself; or

b) sums arise to an executive but not from the AIF or CIS (sometimes called "round the side" arrangements) e.g. payments direct from portfolio companies.  

Who is within the charge?

The charge applies to individuals who, at any time, perform "investment management services" in respect of the investment scheme.

"Investment management services" are likely to encompass almost all work performed by an executive in relation to a fund. They include (i) investment advice, (ii) fund raising for the fund or its investments, (iii) researching, acquiring, managing and disposing of investments and (iv) activities incidental to the foregoing.

Non-residents are potentially within the scope of the charge. See "To what extent does the charge apply to non-residents?" below.

When is the charge triggered?

For the charge to apply the carried interest must "arise" to the executive or a person (other than a company) connected to them. The charge also applies if the carried interest "arises" to somebody else and, essentially, the executive can enjoy it in any way.  For these purposes, a sum "arises", broadly, when a person actually receives or has access to it.

Commercial deferral arrangements can delay the time of "arising" until the deferral period ends.

Example 1

Facts: Executives A, B, C and D are UK tax resident individuals who all perform investment management services in relation to Fund X. An amount that is commercially described as carried interest is payable by Fund X (a limited partnership) to a carry vehicle (also a limited partnership). It is only payable after investors have received back their investments plus a return equating to 7% per annum.

Executives A and B hold their interests in the carry vehicle directly whereas Executive C holds their interest through a personal company tax resident in a tax haven. Executive C does not extract the returns from the carry vehicle from his company. Executive D receives an equivalent return through his holding of special shares in the master holding company used by Fund X. 

The PoA regime 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.  However, private capital businesses may be able to take steps to help executives manage this issue (e.g. considering whether it is possible to include tax distribution provisions in fund documentation to provide the necessary cash).

In addition, there are helpful provisions that apply to all funds, such as rules relating to debt investments under which, broadly:

• loans are treated as made when the lender is under an unconditional obligation to advance the money rather than (the later time) when the advance occurs;
  
  
• certain commercial transactions which leave the fund with substantially the same economic exposure to the debtor group are not treated as "disposals";
  
  
• restructurings of distressed investments are prevented from triggering the end of holding periods; and
  
  
• loans unexpectedly repaid early can be treated as having been held for 40 months.

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 carried interest to be conditionally treated as qualifying. 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:

• the conditionality period ends when certain events occur (e.g. the fund is wound up or four years have passed since the time it ceased to invest), and the AHP is retested at that time. If the result is that the carried interest is all or partly non-qualifying, it is treated as though it arose at the end of the conditionality period and the executive will need to make good the shortfall between the tax they originally paid (i.e. when the carried interest was initially treated as qualifying) and that arising as result of the retesting; and
  
  
• for carried interest to be treated as conditionally qualifying, a claim must be made in the executive's tax return for the tax year in which the carried interest arises.

Are there any other rules relating to AHPs?

As well as the various strategy-specific T1/T2 rules, the general rules relating to debt investments and the rules allowing carried interest to be treated as conditionally qualifying, the AHP regime contains many other provisions. These include general rules determining what counts as a "disposal" and special rules for hedging arrangements. 

Whilst these help ensure that AHPs are measured correctly from a commercial perspective, they, invariably generate complexity. We have, therefore, produced an AHP toolkit (which includes a practical guide) to help you navigate the regime. Please contact us to find out more.

Analysis:

Step 1:  The "relevant period" is from 1 January 2023 until 1 January 2028.

Step 2:  During that time, there are 1,827 days and the only ones on which X did not perform investment management services were Sundays (of which there were 261). Therefore, there were 1,566 applicable workdays in the period.

Step 3: It is necessary to calculate how many of the applicable workdays are UK workdays.

• Period from 1 January 2023 to 29 October 2024: As the carried interest is qualifying, the 572 applicable workdays prior to 30 October 2024 are treated as non-UK workdays.
  
  
• Period from 30 October 2024 to 5 April 2026: The 74 Mondays spent in Germany are not UK workdays, so in the period there were 374 UK workdays.
  
  
• Period from 6 April 2026 to 1 January 2028: As the carried interest is qualifying, all the Tuesdays spent in the UK are treated as non-UK workdays as there were fewer than 60 in each of the tax years (2026/7 and 2027/8).

Therefore, of the 1,566 applicable workdays, 374 were UK workdays.

Step 4: Multiply £1m by x 374/1566. This means that £238,825 of X's carried interest is subject to UK tax.

Is relief available under a double tax treaty?

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. The 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. 

If a non-resident does have a personal UK permanent establishment, HMRC consider that their jurisdiction of residence should give relief against local taxes for the UK trading income charge. However, we understand that several other jurisdictions are unlikely to agree with this view – potentially leading to double taxation.

UK's inpatriate regime

In April 2025, the UK introduced a 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 applicable workdays in the "relevant period" that are not UK workdays (see above) but, the three helpful relaxations (which allow certain UK workdays to be treated as non-UK applicable workdays) do not apply.

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 applicable workdays in the "relevant period" that are not UK workdays (see above), but the helpful relaxation (which allows certain UK workdays to be treated as non-UK applicable workdays) does not apply.

We are closely involved with the implementation and ongoing development of the new regime – both with HMRC directly and through our membership of the tax committees of the key private capital industry bodies.  This involvement, combined with our market knowledge and technical expertise, means we can help clients work through what the new rules mean for their businesses and teams.