An update on carried interest – Autumn Budget 2024
The headlines
Holders of carried interest will be relieved that in the Budget it has been announced that the rate of CGT applying to carried interest (as it arises) will increase from 28% to 32% but not immediately; only on or after 6 April 2025. The decision not to impose an even higher rate will have been influenced by the extensive lobbying which has been taking place to persuade the Government that, if that were to be done, private equity managers would move to favourable jurisdictions such as France, Italy and the Middle East.
However, this 32% rate will only remain in place until the Government has implemented a wider reform package in April 2026. The Government had already sought views on how carried interest should be taxed and this call for evidence closed on 30 August 2024.
Now a Budget document has been published which sets out Government thinking, and they will be consulting further on this until 31 January 2025.
The new proposal
The proposal is that a revised carried interest tax regime will apply which will sit wholly within the income tax (rather than the CGT) regime. Carried interest will be treated as trading profits, subject to income tax and Class 4 NICs. The amount of “qualifying” carried interest (explained further below) subject to tax will be adjusted by applying a 72.5% multiplier.
The tax charge applying under the new carried interest regime will be an exclusive charge. Under the existing regime, carried interest has been taxed according to the nature of the relevant amount coming up from the underlying fund/ its assets. So, for example, amounts representing interest income would have been taxed as interest income; under the proposed regime all amounts will be taxed as deemed trading income.
IBCI
Income Based Carried Interest (IBCI) is already taxed as income, but the IBCI regime has not applied to employment related securities so employees/ directors who have made what is known as section 431 elections have been able to keep outside the IBCI regime. The Government now proposes that the IBCI rules will be amended so that employment related securities are not excluded from it. This will be a significant change as, previously, the IBCI regime has distinguished between the self- employed and the employed.
Carried Interest within the IBCI regime will not be “qualifying” carried interest. The Government is also now going to consult as to what other conditions need to be satisfied to fall within the “qualifying” category. In particular, there may be a minimum co-investment requirement and/ or a minimum time period between a carried interest award and receipt. These new conditions to determine whether carried interest is “qualifying” will be added to the existing IBCI legislation.
DIMF
The existing Disguised Investment Management Fee (DIMF) rules will remain in place.
Non–residents and carried interest
The deemed trade under the revised regime will be treated as carried on in the UK to the extent that the investment management services in relation to which the carried interest arose were performed in the UK, and outside the UK to the extent that the investment management services were performed outside the UK. As a result, non-UK residents will be subject to income tax on carried interest to the extent that it relates to services performed in the UK (subject to the terms of any applicable double tax agreement). This is the same as the approach in the DIMF rules.
What now?
Draft legislation is going to be published during 2025. In the meantime, we and other interested stakeholders will be working to seek to ensure that the proposals put forward by the Government can be implemented in a way which does not result in those involved in the fund management industry leaving the UK for another jurisdiction which they regard as having more favourable rules.
Listen to our Instant Insights on carried interest
Tax Partner, Elizabeth Small explains the changes to how carried interest will be taxed:
Transcript
One of the most eagerly anticipated parts of the Budget speech from the chancellor was in respect of carried interest. A vexed topic of conversation for chancellors over many, many years, perhaps even decades. Famously a beneficiary of carried interest in the private equity market, had said that he paid an effective tax rate of less than his cleaner. That had been changed over the years and current rate of taxation of carried interest is 28%.
Currently, carried interest is subject to the capital gains tax regime and with the concerns regarding the taxation and change of rate of CGT, there was a concern that carried interest would have moved up to an income tax rate of say 45%, which would have been at variance with other jurisdictions which treat carried interest as capital and at a rate of around 30%.
What the Chancellor has announced is that with effect, for carry being cashed in on or after the 6th of April 2025 that the rate will increase from 28% to 32%, but for carry that is cashed in after the 6th of April 2026 that there will have been a whole scale alteration of the carried interest regime, with the potential that carried interest will be treated as trading profits, subject to income tax and Class 4 NICs.
This will apply to qualifying carried interest. What that term means will be debated and explored between now and April 2026, although there are some indications in the press releases that came out with the Autumn Statement as to the initial view of the meaning of a qualified carried interest, but even though the profits will be treated as trading profits post 2026, that doesn’t mean a 45% actual tax rate will apply, because the initial indication is that tax will be subject to an adjustment by applying a 72.5% multiplier to the amount of tax.
This will be a significant increase and change the taxation of carried interest and so it’s going to be very interesting to see how private equity funds and the like adjust their incentivisation of managers between now and April 2026.
