Budget 2024: Carried Interest

Changes to the taxation of carried interest came as no surprise having been referenced in the Labour Party manifesto and wholesale reform is on the agenda.

The most immediate change will be an increase in the headline carry capital gains tax rate from 28% to 32% for carried interest arising from 6 April 2025. However, from April 2026, a new regime is proposed (subject to consultation) which brings carry into the income tax regime, regardless of the underlying character of the return. As such, tax rates of up to 45%, plus 2% NICs could apply although a multiplier of 72.5% will be available where the carry is considered to be ‘qualifying carried interest’. For additional rate taxpayers, this equates to an effective rate of 34.1%, putting the UK on par with France (34%), as imposing the highest taxes on carried interest in mainstream Europe.

So what constitutes ‘qualifying’ carried interest?

Carried interest which is not caught by the IBCI (income based carried interest rules) may be qualifying carried interest. In essence, these rules require a fund to have held its assets for an average holding period of at least 40 months or the return can be classed as income based carried interest and charged to tax under the disguised investment management fees rules. In addition to the minimum holding period, the Government is consulting on introducing either one or both of the further qualifying conditions noted below:

• Aggregate minimum co-investment condition – this reflects the regimes in place in certain other jurisdictions. To simplify the proposal and avoid disadvantaging junior fund managers, this condition would apply on a team rather than an individual basis. The Government acknowledges, however, that this would be a very difficult condition to implement practically. Views are sought on the minimum levels of co-investment and other related matters;
• A minimum holding period – carry holders are generally required to wait for a significant period of time before they receive their carried interest. The proposal provides that individuals would have to hold their interest for a minimum period prior to it being treated as qualifying carried interest. This condition would be in addition to the average asset holding period referred to above. Again, views are sought on the appropriate holding period length and the Government references that respondents to the previously issued call for evidence have quoted an average period of 7 years.

The rules relating to the IBCI will remain the same with one important exception – the removal of the employment related securities exclusion. The exclusion for ERS limited the application of the rules to self employed fund managers eg. a member of an LP or LLP and the effect of its removal will be to bring employees within the scope of the rules.

Finally, there will be no exclusion for existing fund structures from the new regime, the Government’s view being that ‘they do not impose new conditions or requirements which could not reasonably have been foreseen when existing funds were established’.