Last week, the UK Chancellor delivered the new Labour government’s first budget. This announced £40 billion in tax hikes, with rate increases affecting capital gains tax, employers’ National Insurance contributions, and carried interest (amongst others). Other key developments include the abolition of the UK’s “nondomiciled” tax regime and a new Corporation Tax Roadmap. The budget papers also reveal the shape of the government’s intention for the UK taxation of carried interest, giving the asset management community in the UK a lot to think about even in the context of a budget that was (generally) perceived to be positive on business taxation.
We consider below the key budget developments for the asset management sector, with a particular focus on the topic of carried interest taxation.
Carried Interest
April 2025 Rate Increase
The most important budget development for senior asset management teams is around the tax treatment of carried interest. In the short term, it was announced that for carried interest subject to capital gains treatment under current rules, the applicable tax rate will rise from 28% (upper rate) to 32% from April 2025. A change of this nature was widely expected, and a 32% rate is on the lower end of what might have been. The rate differential to dividend tax (at c. 39%) and general income tax (up to 45%) means that current planning to optimise for capital gains treatment where practicable will remain relevant for carried interest for the time being.
April 2026 Income Treatment
More significantly, the budget papers included a document from HM Treasury summarising responses received to this summer’s Call for Evidence on the tax treatment of carried interest and kicking off a further consultation on the design of a new regime for carried interest taxation (the Carry Document).
The most significant revelation in the Carry Document is that from April 2026, carried interest will be brought within the UK’s income tax regime and treated as profits of a “deemed trade” for these purposes. This means that carried interest would be subject to income tax as well as Class 4 National Insurance contributions but with the benefit of a “tax multiplier” such that only 72% of qualifying carried interest is taxed in this way. This approach yields an effective rate of tax of just over 34% for qualifying carried interest.
Unified Carried Interest Taxation
It is clear from the Carry Document that after April 2026, carried interest that meets the qualifying conditions will — in effect — be taxed at a unified single rate of tax, ending the long-established UK approach of looking through to the underlying nature of the returns funding the carried interest (e.g., capital gains, interest) to determine the correct UK tax treatment. The shift towards a more comprehensive regime for the taxation of carried interest, which began with the abolition of base cost shift under the “disguised investment management fee” (DIMF) rules back in 2015, is now reaching its logical conclusion.
Qualifying Carried Interest
It is apparent that carried interest that does not fit within the new “qualifying carried interest” test will remain subject to full income taxation (at rates up to 47%) under the DIMF rules — the new regime will therefore put a considerable premium on what exactly constitutes “qualifying” carried interest. The Carry Document does not set out detailed proposals at this stage (this being a matter for discussion as part of the forthcoming consultation), but it seems clear that the direction of travel is towards a definition of “qualifying carried interest” that
(i) retains or borrows from the existing statutory definitions of “carried interest” in terms of being (broadly) a profit-related return arising by reference to fund investments (this aspect gives some welcome continuity)
(ii) introduces a new requirement for a minimum mandatory co-investment alongside any qualifying carried interest, the quantum of which would lie between 1% and 3% (we suggest the lower end of this range may be more likely) and, significantly, would likely be assessed on a “team as a whole” basis rather than by reference to each individual manager
(iii) introduces a new requirement for a minimum period of time between the award of carried interest and the carried interest’s actually arising to relevant individuals, for which no range is given but that could conceivably align with the existing income based carried interest holding period requirement for underlying fund assets of four years (into which this new requirement is to be inserted)
Much will turn on the specific proposals adopted around the co-investment and holding period requirements, more details of which will emerge through the next phase of consultation. There is clearly scope for a regime that aligns reasonably neatly with common market practice and existing legislation, but the asset management industry should be working to flag potential pitfalls and unintended consequences as part of the consultation.
The Carry Document does make clear that these new requirements and tax treatment for “qualifying carried interest” should apply only to carried interest itself and that genuine co-investment (including any co-investment mandated by the new carried interest regime) will remain taxed under “normal” principles as at present (except that the “new normal” for any capital gains is already 24% rather than 20% as of last week; see below).
Income Based Carried Interest
Separately, the Carry Document states an intention from April 2026 to expand the existing “income based carried interest” (IBCI) rules to apply to all carried interest, removing the current exclusion for carried interest currently within the UK’s employment-related securities regime. Whilst this exclusion does create a largely illogical distinction (in the current regime) between the tax treatment of the same underlying carried interest in the hands of employees and self-employed partners or members of limited liability partnerships, its abolition will mean that funds of all structures and stripes will have to grapple with the monitoring and compliance burden of establishing the average weighted holding period for the underlying fund assets (four years being the magic number for favourable tax treatment). This expansion of IBCI will be implemented alongside any separate requirement to monitor the period of time between carry being awarded and carry arising to relevant individuals. These changes will represent a lot of tax-specific information to track in the context of a large, multistrategy asset manager with a workforce mobile in all respects (between managers, funds, strategies, and jurisdictions and being promoted, reassigned, and/or rewarded in different ways year-on-year). If reading the preceding sentence felt like hard work, that is a taste of things to come.
More helpfully, the Carry Document identifies that the existing IBCI rules (and the strategy-specific exemptions within them) do not cater appropriately for credit and distressed fund strategies. The Carry Document promises more specific consideration in this area, which will be welcome and essential if the IBCI regime is to be extended as proposed; the Carry Document is candid in seeking specialist input from the credit fund industry on this topic.
No Transitional Rules
The Carry Document states that the changes proposed for April 2026 will not be subject to any grandfathering or transitional provisions, on the basis (according to the Carry Document) that all of those changes could have been foreseeable for existing funds at the time of their structuring.
Without taking issue with that statement more generally (although, arguably, one could), one specific and apparently unaddressed issue around IBCI is what should happen for employees holding carried interest awarded prior to April 2026 for whom no monitoring of underlying asset holding periods will previously have been necessary. The lack of grandfathering or transitional provisions may assume that IBCI monitoring would have been undertaken for “other” (nonemployee) carried interest holders in the fund, but if this is not the case (i.e., if all UK carry holders are in fact employees or directors/officers for UK tax purposes) it seems that funds will simply have to figure out their tax monitoring retrospectively (based on trading and financial data). This is just one example of circumstances in which the blunt introduction of the new regime on 6 April 2026 with no concessions to the past may create undue burdens for asset managers.
International Aspects
It is clear from the Carry Document that UK resident individuals should expect their carried interest to be taxed in full under this new regime, except that individuals using the forthcoming “foreign income and gains” regime (see below) may be exempt from UK tax to the extent the performance of their investment management services takes place outside the UK. For those individuals, the underlying source of the gains or income funding the carried interest will no longer be relevant (with the abolition of the “nondomiciled” regime), and the test will look to the place of performance of the relevant services.
Non-UK resident individuals will, conversely, become liable to UK tax on carried interest to the extent their related investment management services are performed in the UK. Whilst the Carry Document correctly states that this position is the same as under the current DIMF rules, the reality is that in most “normal” carried interest structures at present no DIMF should typically arise, and so the potential for nonresident taxation for fund managers remains somewhat academic. This will no longer be the case under the UK’s new regime for carried interest — nonresident fund managers who work some of the time in London will find themselves paying UK tax on their carry for the first time unless they are able to secure relief under a double tax treaty.
The question of double tax relief itself could cause some significant complexity, not only for nonresident fund managers but more importantly for the many senior fund executives resident in London who are also U.S. citizens and liable to U.S. taxation on a worldwide basis. There are some known pitfalls within the existing DIMF rules around the fact (for example) that the UK would seek to tax DIMF income as “trading income” whereas the U.S. would still be looking to tax underlying investment income or gains, creating a mismatch that could derail claims for double tax relief. That mismatch will now be imported on a much larger scale to the UK’s new regime for carried interest taxation, such that a U.S. citizen based in London could (for example) be liable to tax on deemed trading income for UK tax purposes and tax on underlying capital gains for U.S. tax purposes. Whether and how double tax credit may be available (especially if the UK does not take the initiative on aligning its own tax credit rules to accommodate the new regime first) will be a significant issue for U.S.-based funds to work through as part of the next phase of consultation.
Next Steps
The changes proposed in the Carry Document are far more substantial than the “headline” increase in the rate of effective taxation in the UK. The key to positive progress before April 2026 will be in the quality of information and responses submitted as part of the next round of consultation to 31 January 2025 and technical engagement on any draft legislation released thereafter. We are monitoring developments in this area closely and expect to make substantive submissions to the consultation and to support our clients in making their own submissions. If there are specific issues you would like to discuss, please do get in touch with one of our London tax team.
It is encouraging that the Carry Document sets out a phased process for consultation and draft legislation over a relatively long period (as well as suggestions of bilateral meetings with HM Treasury officials and a wider working group), but for the asset management community to use that process wisely will require strong working partnerships between those with industry knowledge at the coal face and the advisers who follow the intricacies of the existing carried interest legislation.
Other Changes: Employment Taxes, Corporation Tax, and “Nondomiciled” Status
Key Tax Rates
The budget made no changes to the current rates of corporation tax, income tax, value-added tax, or employee or self-employed National Insurance contributions.
Capital gains tax for individuals (other than with respect to carried interest, discussed above) increased from 18% to 24% for higher rate taxpayers (and from 10% to 18% for basic rate taxpayers) effective 30 October 2024.
The capital gains tax rate change was accompanied by some very broad “antiforestalling” rules to prevent contracts entered into prior to 30 October but not completed as at that date from benefiting from the lower, older rates of tax unless the taxpayer can show that this timing was not a purpose (not just a “main purpose”, any purpose) of entering into the contract. These rules should not (generally) affect genuine commercial transactions, but any fund managers who have entered into any agreements to sell assets or otherwise crystallize capital gains in the run-up to 30 October 2024 may wish to take advice on the application of this sweeping rule.
Employer’s National Insurance Contributions
The major revenue raiser in the budget (accounting for some £25 billion of the £40 billion tax rises) was the changes to employer’s National Insurance contributions (a form of payroll tax), which will rise from 13.8% to 15% from April 2025. There will also be some downward adjustment to the thresholds at which these contributions are payable, which will disproportionately affect businesses (which could include certain private equity portfolio companies) that rely on part-time, flexible hours or low-paid labour. Even after the associated corporation tax deduction, these changes represent a significant additional payroll cost for employers, and the UK asset management industry will count the cost for its relatively highly paid employees. This rate change could also prompt some fund managers (notwithstanding the expansion of the IBCI regime) to consider again whether their UK entity should be set up as a limited company or a limited liability partnership (whose senior members can, subject to certain conditions, fall outside the scope of employer’s National Insurance contributions).
Corporation Tax
The UK’s corporation tax rules have remained largely stable through the budget. The key 25% corporation tax rate has been maintained and guaranteed for the duration of this Parliament, and many key allowances such as full expensing, the annual investment allowance, research and development reliefs, and the UK patent box and intangible assets regimes all being maintained. The budget papers included a new Corporation Tax Roadmap that generally offers continuity and stability on the UK tax front for business, and we would not generally expect the minor corporation tax changes outlined in the Corporation Tax Roadmap or otherwise published as part of the budget to have a significant impact on the asset management industry.
It was helpful to note that the budget materials imposed no further restrictions or conditions on the rules around UK “qualifying asset holding companies” (QAHC), and the government officials acting on the QAHC Working Group were quick to issue minor clarifications to support consistency for the QAHC regime through other budget changes such as the abolition to the nondomiciled tax regime. The government has invested significant time and effort in the design and implementation of the QAHC regime, and there was nothing in the budget to suggest any retrade or surprises in this area.
Nondomiciled Status
In a move that surprised no one, the Labour government has announced the abolition of the UK’s historic “nondomiciled” basis of taxation from April 2025. Currently, UK resident individuals who claim a separate “domicile” outside the UK can elect (and in some cases pay an annual charge) to be taxed on non-UK income and gains only if these are remitted into the UK. Over the years, this has arguably been a significant factor in attracting international talent into the top end of the UK asset management industry.
From April 2025, this regime will be replaced with a purely residence-based tax system: New residents to the UK (or returners who have been away for 10 or more years) will benefit from 100% relief on non-UK income and gains for the first four years from their return, after which worldwide UK taxation will apply for UK residents as normal.
Formerly nondomiciled individuals will benefit from rebasing for offshore assets to 5 April 2017 and will have some ability to bring previously untaxed foreign monies into the UK at reduced rates of tax (from 12% to 15%) over the coming three years.
This is a very significant change for individuals currently claiming the nondomiciled basis of UK taxation, and they should seek specialist and personalised advice ahead of the introduction of these new rules.
The forthcoming regime for new arrivals to the UK may go some way to attracting new international talent to the UK asset management industry, but the tax reliefs on offer arguably compare fairly poorly with similar regimes in other European jurisdictions such as Italy and France.
Other Issues
A new consultation was announced on the tax treatment of Employee Ownership Trusts and Employee Benefit Trusts. This may be relevant to some asset managers or to their portfolio companies (which in a UK context often maintain management equity within a form of nominee or employee benefit trust arrangement). We will be reviewing this consultation for any specific issues we feel may invite appropriate submissions from or for the asset management industry.
The budget announced the introduction of UK value-added tax at 20% on private education fees from January 2025. This move had been widely expected but may disproportionately affect UK-based staff in the asset management industry, especially those who move to the UK and intend to send their dependents to international schools in London.
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