Government publishes update on UK taxation of carried interest

The government has today published an update on carried interest (see here). The main announcements are summarised below.

Further detail

Additional qualifying carried interest conditions abolished

It was previously announced that from 6 April 2026, carried interest returns would be taxed as deemed trading income, subject to UK tax and self-employed NIC at a combined effective rate of 47% or 34.075% where certain qualifying conditions were met.

The government initially announced that they were exploring the following conditions (i) a minimum level of team co-investment and (ii) a minimum holding period for carried interest.

Following feedback received during the consultation period, the government has stated it recognises implementing these additional conditions would have a number of practical challenges, with a risk of creating unintended and/or distortive outcomes and have decided not to proceed with implementing either of these conditions.

Some relaxations announced for Non-UK tax residents

As previously announced, non-UK residents will be brought within the charge to UK tax on carried interest to the extent that their carried interest relates to services performed in the UK.

Where carried interest is within the charge to tax in the UK as well as the individual’s country of residence, this gives rise to a risk of double taxation due to uncertainties relating to the other jurisdiction’s approach to the application of double tax treaties.  Although there are established mechanisms to resolve international tax disputes, the government acknowledges that the potential need to rely on such processes creates uncertainty, which in turn risks discouraging fund managers from choosing to work in the UK.

In recognition of this uncertainty, the government is proposing to introduce three statutory limitations to lessen the impact on internationally mobile carry recipients:

• A UK workday threshold whereby non-UK residents who have less than 60 workdays in the UK in the relevant tax year will not need to consider whether they come within the rules.
• Any UK services performed in a tax year to be treated as if they were non-UK services if three full tax years (in addition to the then current tax year) have passed during which time the individual was neither UK tax resident nor met the 60-day UK workday threshold.
• Any services performed by non-residents in the UK prior to 30 October 2024 (when the new rules were first announced) to be treated as if they were non-UK services.

We note that the measures will not eliminate the risk of double taxation entirely but are expected to make the rules more workable for many short-term visitors to the UK.

The IBCI rules (to be known as the Average Holding Period condition)

Given carried interest returns under the new carry regime will be subject to tax as deemed trading income, (regardless of the nature of the underlying returns), the IBCI rules, as they are currently known, will be referred to as the Average Holding Period (“AHP”) condition going forwards. 

Application to Employment Related Securities: As was announced at the Autumn Budget 2024, the current exemption from the AHP condition for individuals who hold Employment Related Securities (“ERS”) will be removed with effect from 6 April 2026, meaning these rules will apply equally to employees and LLP members.

Amendments to the AHP condition: The government’s stated purpose of the AHP condition is “to exclude funds which do not carry on a long-term investment strategy” but it is recognised that there can be practical difficulties in applying these rules for particular fund strategies, including private credit, notwithstanding that they may have a long-term investment strategy.

Therefore, the government have announced that they will make targeted amendments to the AHP condition, which are intended to prevent the AHP condition from producing inequitable outcomes for particular strategies, including:

• Direct lending funds: Removing the rule (in section 809FZQ ITA 2007) which currently treats carried interest arising from a direct lending fund as automatically failing the AHP condition unless an exemption applies.
• Bespoke credit fund provision: Introducing a new provision for credit funds of all types which will deem debt investments to be made and disposed of at a specific time (the “T1/T2” rules). This will also mean the specific provision for loan to own strategies (at section 809FZV) will be removed as it will become redundant.
• Fund of funds and secondaries: Replacing the existing rules (at sections 809FZO and 809FZP) with a single provision covering both strategies which is intended to streamline the T1/T2 rules and better reflect commercial practice.
• Unwanted short-term investments: Amending the existing rules (at section 809FZF) to apply to a wider range of scenarios (such as loan syndications and bundles of assets acquired by secondary funds).
• Other: It has also been stated that other technical issues will be addressed, with the specific examples given being the application of the scheme director condition (at section 809FZK) and the treatment of tax distributions to prevent dry tax charges.
• Further, the approach to calculating the average holding period of investments and conditionally exempt carried interest will continue to apply.
  
  

Other key points

ERS rules remain: Other than the removal of the ERS exclusion from the AHP rules, (as noted above), the new rules will not otherwise impact the application of the ERS rules to awards of carried interest which will continue to apply to awards of carry.

Payments on account: The government has confirmed that tax due on carried interest will be included in the calculation of payments on account due for the following tax year. Fund executives will therefore need to consider whether it is appropriate to make claims to reduce their payments on account given the irregular and unpredictable nature of carried interest to avoid overpayments of tax.  This may put further pressure on the fund management firm to provide visibility of potential carry distributions, particularly given that, where claims to reduce the payments on account prove to be excessive, interest will be payable.

Methodology for determining carry attributable to UK services: The government intends to mandate a time-based apportionment method to determine how carried interest is apportioned between investment management services performed in the UK and those performed outside the UK with the objective of providing certainty for taxpayers, as well as enabling HMRC to effectively monitor compliance.

Next steps

The government intend to publish draft legislation for technical consultation ahead of Parliament breaking for the summer in late July. In addition, officials will continue to meet with stakeholders, including through the technical working group, in order to undertake that technical consultation.

Please speak with your usual Deloitte contact or any of the contacts below if you would like to discuss.