Executive summary

The capital gains tax rate on carried interest in the United Kingdom (UK) increases as of 6 April 2025 to a single rate of 32% (up from 28% or 18% for basic rate UK taxpayers).

In the Autumn Budget 2024, the UK Government confirmed that it would introduce a new regime for the taxation of carried interest from 6 April 2026. And, for the year prior to the introduction of the new regime, the capital gains tax rate on carried interest will increase to 32%. (For background, see EY Global Tax Alert, UK Autumn Budget delivers significant tax increases but seeks a plan for the future, dated 31 October 2024.

This Tax Alert sets out the Government's proposals and the next steps, before the new regime is implemented. His Majesty's Treasury (HMT) has consulted and, together with HM Revenue and Customs (HMRC), is engaging with stakeholders on the technical detail of the proposals. Ernst & Young LLP (EY UK) is part of HMT's working group on carried interest reform. To obtain a copy of EY UK's responses to HMT's calls for evidence, get in touch with your usual contact or the contacts listed at the end of this Alert.

What is proposed

From 6 April 2026, HMT is proposing that carried interest would be taxed as profits of a deemed trade, subject to income tax and class 4 national insurance contributions.

There would be special computational rules for "qualifying carried interest." These rules will reduce the tax rate payable to circa 34 % (from circa 47%).

Carried interest will be "qualifying" where it is not income-based carried interest (IBCI). HMT is exploring amending the IBCI rules by:

• Introducing a minimum holding period and minimum co-invest requirement
• Removing the employment-related securities (ERS) exemption

These areas were the subject of a call for evidence that closed on 31 January 2025. HMT has indicated that it may propose further amendments to the IBCI rules to ensure they operate effectively. The disguised-investment-management fee (DIMF) rules will be retained.

HMT is not proposing to exclude existing funds from the new regime, nor to include transitional provisions.

Why is the taxation of carried interest changing?

The Government's view is that carried interest should be taxed as a reward for the provision of investment management services. It also recognizes that carried interest has unique characteristics that set it aside from other awards, hence the bespoke effective tax rate for qualifying carried interest.

What areas might need more thought?

There are several areas within the proposed new regime that require further consideration, including the following.

Territorial scope: non-UK residents

HMT is proposing that individuals should be taxed on their carried interest to the extent that the carried interest relates to services provided in the UK. This means that executives may be taxed in the UK on carried interest, even if they are non-UK resident at the time of receipt (e.g., where an executive has left the UK or visits the UK for a short period of time to perform services). This approach is similar to the territoriality concept in the DIMF/IBCI rules. This is likely to create administrative complexity and may negatively impact the future flow of talent into the UK.

Territorial scope: double taxation

HMRC is of the view that the UK has a right to tax amounts in relation to services performed in the UK as profits of a deemed trade regardless of where the individual is resident when the amounts arise. There will be mismatches between treaty qualifications (i.e., business profits in one location vs. capital gains in another). It is anticipated that many locations may not allow a tax credit for tax on UK business profits levied on a UK non-resident against local capital gains tax levied on one of their residents. Executives may therefore be subject to double taxation. Unless the Government introduces statutory protection to remove the risk of double taxation, overseas executives who spend modest amounts of time in the UK are likely to relocate this business to other jurisdictions.

Amendment to IBCI rules

The proposal to remove the ERS exemption from the IBCI rules will bring employees within the rules for the first time. Funds will need a weighted-average holding period of at least 40 months (assuming that the required holding period is not changed) for the IBCI rules not to apply. HMT recognizes that the removal of the ERS exemption will have a disproportionate effect on private credit funds, many of which seek to rely on the ERS exemption. HMT has indicated that it will propose targeted amendments to the IBCI rules for private credit funds. These changes may be positive. We expect to receive the detail of proposed changes when draft legislation is published later in 2025. The current IBCI rules for real estate and secondary funds contain narrow simplification provisions. It would be helpful if the rules were expanded to reflect the nature of those funds.

Co-investment and minimum holding period requirement

The existing DIMF regime already sets out what constitutes carried interest. It is not clear why further qualifying criteria is required. Prescribing a specified level of co-investment or a set holding period to all types of fund may make the rules unnecessarily complex. It may also disadvantage more junior executives.

What's next?

HMT is considering responses to the latest call for evidence and continues to discuss the proposals with key stakeholders. EY UK will continue to engage with HMT and HMRC on this area. HMT plans to release draft legislation in May 2025. Further, HMT is likely to publish its response to the latest call for evidence. Once HMT has published draft legislation, further detail on the areas outlined above should be available. Those affected by the proposals will want to monitor developments.