In line with its election manifesto the new Labour government will amend the tax treatment of carried interest.
From 6 April 2025 until 5 April 2026 there will be an interim increase in the special capital gains tax (“CGT”) rate for carry from 28% to 32%.
From 6 April 2026 carried interest will be taxed under the income tax regime and also subject to national insurance contributions (“NICs”). Where a carried interest meets certain qualifying criteria a 72.5% multiplier will apply lowering the effective additional rate of income tax from 45% to an effective rate of 32.625% (and, in practice, the NICs from 2% to 1.45%), meaning an aggregate income tax/NICs rate of 34.075%.
In addition, the government is consulting on whether further specific conditions will need to be met for return to be characterised as carried interest.
Immediate Changes
There will be no immediate changes to the carried interest regime for amounts realised on or before 5 April 2025.
From 6 April 2025 for one tax year a special CGT rate of 32% will apply to any carried interest realised. This rate maintains an 8% delta between the special CGT rate for carried interest and the new 24% top rate of CGT.
New Regime
The government’s stated view is that carried interest should be treated as a reward for the provision of management services. But it is accepted that carry is different to typical employment income in that it relates to share of profits from a fund, any payment is subject to a lengthy time lag, and there is a genuine risk that it is never received.
The government will therefore introduce a special tax regime for carried interest. From 6 April 2026 carried interest will be treated as a trading profit, taxed under the income tax regime and subject to class 4 NICs (self-employment). But for “qualifying” carried interest a 72.5% multiplier will apply to lower the effective:
- additional income tax rate from 45% to 32.625%; and
- class 4 NICs from 2% to 1.45%;
meaning an aggregate income tax/NICs rate of 34.075%.
It appears that the new rate will apply to all carried interest (not falling within the existing income based carried interest (“ICBI”) rules), i.e. including capital gains, dividends and interest, which may ameliorate the impact of the changes, especially for debt funds which will expect to have significant interest income (otherwise subject to income tax at 45%).
The ICBI rules will also be amended to remove the exemption for employment related securities. This effectively means that regardless of how a carried interest is acquired, to benefit from the special treatment, the underlying assets of a fund must be held for at least 40 months on average. The existing disguised investment management fee anti-avoidance rules will also continue to apply.
Further Consultation
The government will also consult with industry about whether further specific criteria must be met to be treated as qualifying carried interest. These additional conditions would form part of the IBCI rules and could include either or both:
- a minimum co-investment requirement; and
- a minimum holding period for the carried interest rights which is separate from and likely to be longer than the 40 month average holding period for the assets.
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