Overview of the draft legislation implementing the proposed changes to the UK tax treatment of carried interest

Significant changes to the UK tax treatment of carried interest were announced in the October 2024 Budget and are due to come into effect from 6 April 2026. Comments on the background to and impact of these changes and the government’s consultation on them were discussed in our previous briefing on this subject (see here).  

There is now greater clarity on the position, following publication of the draft legislation to implement these changes. Issued on 21 July 2025, the draft legislation will be subject to a final technical consultation, open until 15 September 2025.  

We summarise below the key aspects of the new regime which, subject to any final revisions to the drafting, will take effect from 6 April 2026:

• All carried interest arising to an individual will be treated as profits of a trade and subject to income tax and national insurance contributions (NIC) if the individual is UK resident in the tax year or otherwise to the extent that the trade is carried out in the UK (subject to the limitations, reliefs and temporary non-residence provisions discussed further below).  The effective rate of tax will be 47% for “non-qualifying” carried interest (assuming income tax at 45% plus 2% NIC) and just over 34% for “qualifying” carried interest (after applying a 72.5% multiplier to the trading profits).
  
  
• Qualifying carried interest treatment will depend on the (weighted) average holding period (AHP) of the investments made by the scheme and by reference to which the carried interest is calculated.  The ‘relevant proportion’ of a sum of carried interest to be treated as qualifying carried interest will be calculated on a sliding scale, from 100% if the AHP is 40 months or more, reducing to 0% where the AHP is less than 36 months.
  
  Under current law, these AHP rules apply to “income based carried interest” and are not relevant to employees (only partners). With effect from 6 April 2026, they will be applicable to all carried interest (the carve out for employment related securities (ERS) being omitted under the draft legislation).   It should also be noted that any charges under the benefit in kind and ERS rules will take priority to the new carried interest income tax regime, with relief given for any double taxation.
  
  The draft legislation also contains certain other revisions to the provisions for determining the AHP, including specific provisions now dealing with credit funds and simplified rules for funds of funds.  As per the existing legislation, there is also the ability in certain circumstances for the relevant proportion to be treated as 100% on a provisional basis, subject to adjustments at a later stage.
  
  
• In the case of non-qualifying carried interest, the part of the trade treated as carried on in the UK will be based on the proportion of the applicable workdays which are UK workdays (as per the definitions explained below).
  
  
  • A day will count as an applicable workday if the individual performs any investment management services (whether or not under the arrangements in question) on that day in the relevant period.
    
    
  • A day will count as a UK workday if the individual spends more than 3 hours performing investment management services in the UK (whether or not under the arrangements in question) on that day.
    
    
  • The relevant period will be the period beginning with the first day on which the arrangements “contained provision that contemplated that the carried interest [..] may arise from the scheme” (the precise meaning of this is currently unclear) and ending with the last day on which carried interest arises to that individual from the investment scheme.
    
    
  • Services performed whilst travelling to or from the UK by sea, air or the Channel Tunnel will be assumed to be carried out overseas, even during the part of the journey in or over the UK, beginning with when the individual boards the aircraft, ship or train, and ending with when they disembark.
    
    
• In the case of qualifying carried interest, the part of the trade treated as carried on in the UK will similarly be based on the proportion of the applicable workdays which are UK workdays (as explained above), but subject to further significant limitations where the qualifying carried interest arises to a non-UK resident as follows:
  
  
  • The following UK workdays will be disregarded:
    
    
    • Any UK workday prior to 30 October 2024;
      
      
    • Any UK workday in a non-UK tax year; and
      
      
    • Any UK workday prior to a period of 3 or more non-UK tax years.
      
      
  • A tax year will count as a non-UK tax year if the individual is non-UK resident and there are fewer than 60 workdays in the year.
    
    
• Individuals who are non-UK resident may also be able to claim double tax treaty relief, where applicable, and guidance is anticipated on this in due course.
  
  
• For individuals subject to the new Qualifying New Residents (QNR or “FIG”) special 4-year regime introduced with effect from 6 April 2025, the non-UK trade part of qualifying carried interest will be treated as qualifying foreign income and therefore eligible for tax relief.  The non-UK trade part of non-qualifying carried interest will not benefit from this treatment.  However, the “foreign pre-arrival proportion” of non-qualifying carried interest will be treated as qualifying foreign income, such proportion being the proportion of applicable workdays that were not UK workdays carried out in the period when the individual was not yet UK resident.    
  
  
• To be treated as carried interest, and as per the existing legislation, the sum must be a “profit-related return” and, broadly, be subject to a “significant risk” of not arising, with a ‘safe harbour’ being where a sum arises only after all, or substantially all (relevant) investments have been repaid to participants and external investors have received a preferred return of at least 6% compounded per annum on their (relevant) investments. Where the return does not constitute carried interest (and does not otherwise constitute a co-investment – see below), it will continue to be treated as a disguised investment management fee (DIMF).  As such, it will similarly be treated as profits of a trade, subject to income tax and NICs at an aggregate effective rate of 47% if the individual is UK resident or otherwise to the extent that the trade is carried out in the UK.  As per the existing legislation, the latter will depend on the extent to which the individual performs the investment management services in the UK or overseas.
  
  
• The scope of the carried interest and DIMF rules will be widened by the expansion of:
  
  
  • the definition of an ‘investment scheme’ to include Alternative Investment Funds, in addition to Collective Investment Schemes, and therefore corporates which would previously have been outside its scope unless an OEIC; and
    
    
  • the definition of investment management services to include “the provision of investment advice” and “any activity incidental or ancillary to any activity” which falls within the investment management definition.  
    
    
• Carried interest which arose as a gain to an individual in 2025/26 or earlier and during a period of temporary non-UK residence will be treated as profits of a trade of that individual in the tax year of resuming UK residence (the draft legislation isn’t entirely clear in this regard, but this is the intention according to the explanatory notes). Such sums will be subject to income tax and NIC, but at the same effective rate of tax as for qualifying carried interest, i.e. at just over 34%.   Significantly, the temporary non-residence rules will be expressly disapplied for any gain which arises other than in the circumstances noted above and so should not apply to carried interest which arises to a non-UK resident individual after 6 April 2026.  
  
  
• Individuals who have realised carried interest gains whilst non-UK resident will need to be clear on their position under the UK’s statutory residence test and the requisite period of non-UK residence so as not to fall foul of these temporary non-residence rules (which will typically require a period of non-UK residence of at least 6 complete tax years, if it follows a period of at least four tax years of UK residence).  
  
  
• Co-investments arising to a UK resident will continue to be subject to capital gains tax (CGT) at 24% or income tax at the dividend rate of 39.35% as applicable (i.e. depending on whether they arise in capital or income form).  The draft legislation tweaks the existing definition for co-investment, seemingly to emphasise that it requires the return to be an “arm’s-length return” on the basis set out in the legislation and not otherwise.  
  
  
• Co-investments arising to a non-UK resident, will continue to be subject to the temporary non-residence rules for income tax and CGT purposes.

Example: Qualifying carried interest and non-UK residents

By way of example, say:

• an individual commences providing investment management services as a UK resident in October 2021 and is awarded carried interest rights,
  
  
• the individual does 100 workdays in 2021/22, and 200 workdays in each of 2022/23, 2023/24 and 2024/25 (100 of the latter being done before 30 October 2024) and in 2025/26,
  
  
• the individual then becomes non-UK resident with effect from 6 April 2026 and does 30 UK workdays and 70 non-UK workdays after that date, before receiving their carried interest in October 2026,
  
  
• the scheme holds its relevant investments for more than 40 months.

Under the new regime, it appears that the position will be as follows:

• There would be 1000 applicable workdays in total.
  
  
• The 600 applicable workdays undertaken before 30 October 2024 will be disregarded as UK workdays.
  
  
• The 100 applicable workdays in 2024/25 and 200 in 2025/26 will be treated as UK workdays.
  
  
• The 100 applicable workdays in 2026/27 will be disregarded as UK workdays, as the individual was non-UK resident and they did fewer than 60 UK workdays in that tax year.
  
  
• So, 30% (i.e. 300/1000) will be treated as profits of a UK trade and the other 70% as profits of a non-UK trade.  
  
  
• The carried interest will be qualifying carried interest and so taking into account the above percentage split, the overall effective rate of tax will be just over 10% (i.e. 30% of just over 34%).

Next steps

It should be emphasised that the above is a high-level summary only of some of the key aspects of the proposed new rules, which also include anti-avoidance provisions and other points of detail e.g. relating to permitted deductions, tax distributions, deferred sums and carried interest elections (whereby individuals can elect to treat carried interest as arising to them at an earlier time).  

A careful review and analysis of an individual’s position will be required to understand how this regime will apply in any given situation, depending on the arrangements in place and individual’s personal circumstances.  

In light of the above changes, individuals affected by these changes should:

• consider whether or not their carried interest is likely to be qualifying carried interest (individuals who previously benefited from the carve out for ERS will need to review AHPs for the first time);
  
  
• review, and start to / continue to maintain, workdays records, both for work carried out in the UK and abroad and where this is carried out on a journey to or from the UK; and
  
  
• review their residence plans and the implications of these for the treatment of their carried interest (whether they have already relocated or are planning to relocate in future).