New UK carried interest tax regime - summary of draft legislation published

On 21 July 2025, HMRC published 48 pages of draft legislation on the new tax regime for carried interest, following extensive consultation with industry stakeholders. The draft legislation has broadened the application of the rules, and many investment managers, structures and individuals that were not previously within the scope of the rules will now need to consider the application of these rules carefully. While the draft legislation will take some time to work through in detail and is subject to a further eight-week consultation process, we have summarised the key changes and revised framework of the carry legislation below.

Background

• Carried interest is a form of performance-based reward for investment managers, typically structured as a share of the profits generated by an investment fund managed by those investment managers.
• In last year’s Budget, the Government announced that from 6 April 2025, the capital gains tax rate applying to carried interest will increase to 32% (from 28% previously). It was also confirmed that from 6 April 2026, a revised tax regime for carried interest will be introduced and all carried interest will instead be taxed within the Income Tax framework, treated as trading profits subject to income tax and Class 4 National Insurance (NI).
• In June, the Government published its official response and policy update on the taxation of carried interest, following extensive consultation with industry stakeholders. Most notably they confirmed that additional conditions, regarding a minimum co-investment or minimum holding period before carried interest is realised, would not be introduced.
• Last week the first draft legislation regarding the new carried interest rules was released - bringing some clarity regarding the application of the new rules.

Key Highlights

• Carried interest will be treated as trading profits subject to income tax and Class 4 NIC (at combined rates of up to 47%) – this will be relevant to the calculation of any payments on account due.
• A 72.5% multiplier will apply to qualifying carried interest - reducing the effective rate to c.34.1%.
• Expansion of the definition of 'investment scheme' and 'investment management services', alongside the removal of the employment related securities (ERS) safe harbour, will bring more individuals within the scope of these rules and the disguised investment management fee (DIMF) rules.
• Where the average holding period (AHP) of investments is 40 months or more, carried interest will be qualifying carried interest. Several key changes have been made to the AHP rules (previously income based carried interest rules) applying to certain investment funds (most notably for credit funds and funds of funds/secondaries).
• Changes to the territorial scope of the rules will bring some non-residents within the scope of UK tax on the receipt of qualifying and non-qualifying carried interest.

Draft legislative changes

Taxation of carried interest as trading profits

• An investment manager will be treated as carrying on a deemed trade in respect of all investment management services performed. Carried interest arising will be treated as the profits of this trade and will be subject to income tax and Class 4 NIC (at combined rates of up to 47%).
• If the carried interest meets the definition as qualifying carried interest (see below), a 72.5% multiplier will apply, reducing the effective rate to c.34.1%.
• In practice, some carried interest received might be qualifying carried interest, and some might be non-qualifying, giving a blended effective tax rate.

Changes to definitions and scope of the new rules

• The definition of 'carried interest' and 'arising' broadly mirrors the definition of carried interest included within the existing DIMF legislation.
• The definition of 'investment management services' has been expanded to include (i) the provision of investment advice and (ii) any activity incidental or ancillary to those listed in the legislation. The term remains broadly defined and non-exhaustive.
• The definition of 'investment scheme' is now expanded to include alternative investment funds (AIFs) and other corporate structures that may previously have been outside the scope of the rules. This substantially broadens the scope of the DIMF and carried interest rules and the types of structures that the rules will be applicable to.
• The draft legislation accommodates for carried interest in respect of specific investment structures and strategies, but also introduces complexity (see AHP comments below).
• The draft legislation specifically provides that 'tax distributions' are to be treated and taxed as carried interest.

Qualifying carried interest – Average Holding Period rules

• The relevant proportion of carried interest that is treated as qualifying carried interest is given by the basic 40-month rule. This rule is largely unchanged from the existing income based carried interest legislation, with 100% of the carried interest being qualifying carried interest where the AHP is 40 months or more, and none of the carried interest will be qualifying carried interest where the AHP is less than 36 months. A proportionate amount is determined to be qualifying carried interest where the AHP is between 36 months and 40 months.
• The removal of the ERS safe harbour means that more individuals within the scope of the carried interest rules (ie employees and self-employed investment managers) will need to consider and the AHP and the complexities of these rules for the first time from 6 April 2026.
• The existing income based carried interest rules contain specific tests to determine the time of acquisition and disposal for various assets, structures and investment strategies. The draft legislation retains the specific tests for certain investment funds with amendments ie, venture capital funds, significant equity stake funds, controlling equity stake funds, real estate funds, credit funds and funds of funds (each fund type has a specific definition in the draft legislation).
• The notable amendments include:
  • The tests for venture capital funds and significant equity funds have largely been retained from the existing income based carried interest rules save for the replacement of the 'scheme director' condition with the requirement for the investment scheme to be entitled to “relevant rights” relating to company reasonable for the size and nature of the investment.
  • There will no longer be a presumption that credit funds will be treated as non-qualifying unless falling within a narrow exclusion (as is the case under the current legislation). The definition of a credit fund and debt investment is proposed to be much broader. The acquisition date of certain debt investments can be backdated to when a 'significant debt investment' was first made. Certain disposals are disregarded until a 'relevant disposal' is made, extending the AHP. The existing narrow 'loan to own' rules have been removed and replaced with similar conditions that extend the AHP where in substance the same investment is retained (eg, credit facilities, debt for equity transactions).
  • Fund of funds – the draft legislation combines the existing income based carried interest rules for fund of funds and secondary funds into one definition (with amendment). The existing test requiring 75% of a fund’s value to be invested by external investors is replaced with a genuine diversity of ownership test as seen in the QAHC rules. Similar AHP rules are retained from the existing legislation.
• The AHP rules will also be extended to backdate certain acquisitions/disposals between associated investment schemes.
• The scope of the existing unwanted short term investments rules will be extended amongst other amendments, the deadline to dispose of an asset has increased from six months to 12 months.

Territorial scope

• Non-UK residents will be subject to UK tax on the proportion of qualifying and non-qualifying carried interest that relates to investment management services performed in the UK during the relevant period (broadly the period from the commencement of the carried interest arrangements to the last day on which a sum of carried interest arises to the individual). Certain concessions and exclusions will be introduced in relation to qualifying carried interest:
  • Any services performed in the UK prior to 30 October 2024 will be treated as if they were non-UK services
  • Any UK workday before three or more years of non-UK tax residence will be disregarded
  • Any UK workday in a tax year where the individual was non-UK residence and there were fewer than 60 UK workdays in the year
  • Where there is an applicable DTA, the UK services must be attributable to a UK permanent establishment of the relevant individual.
• Whilst the draft legislation introduces helpful transitional rules for non-UK tax residents, it would appear that they may still be exposed to UK tax in relation to any non-qualifying carried interest that is attributable to even brief periods of work in the UK.
• For these purposes, a workday is any day on which investment management services were performed, and a UK workday is any day in which more than three hours was spent performing investment management services in the UK. This test applies to all investment management services and not work duties spent between different investment schemes.
• The temporary non-resident rules are amended such that carried interest arising to an individual whilst a temporary non-resident may be taxed as trade profits for the period they re-acquire UK tax residence. Where these rules are in point, the carried interest would benefit from the 72.5% multiplier.

Permitted deductions and double tax relief

• The draft legislation has updated the definition of permitted deduction to be the consideration paid or paid on behalf of an individual wholly and exclusively for the entitlement to carried interest minus any amounts of any consideration already deducted in calculating trade profits in earlier tax years.
• Amounts which were previously taxed under the ERS rules will no longer be 'permitted deductions' which can be offset against caried interest sums, although separate provisions have been introduced to provide relief for double taxation in this regard. It should be noted that an individual would need to make a claim for relief (rather than this being automatic).
• Under the new regime, taxpayers may elect for their carried interest to be chargeable as profits arise (rather than when they are received). Double tax relief is available for tax paid on chargeable gains deemed to arise to the taxpayer under the similar election found at section 103KFA TCGA 1992 of the existing legislation. Any existing elections made under section 103KFA are treated as an election made under the new regime. This provision seeks to accommodate double tax relief for investment managers who are taxed on their carried interest as it arises in other jurisdiction.

Next steps

The draft legislation extends the scope of the carried interest rules to asset managers and structures that may have previously fallen outside the rules. In particular, the broadening of the definition for applicable credit funds will be a welcome change for the sector, presenting an opportunity for credit funds to review their existing remuneration structures. With the introduction of certain corporate structures within the scope of the rules, investment managers will need to review whether a structure falls within the expended definition of an investment scheme for the purposes of the DIMF rules and carried interest rules.

The technical consultation period will end on Monday 15 September 2025. Grant Thornton continues to participate in the HM Treasury and HMRC working group and is gathering feedback from clients to inform our submissions throughout this consultation process.

Should you wish to discuss the impact of the draft legislation, please do note hesitate to reach out to Ami Shah, Terry Heatley, Alex Bulgarelli. Furthermore, should you require assistance on whether a structure would fall within the extended definition of an investment scheme, our regulatory team can assist with this assessment.