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Draft UK Carried Interest Legislation: Key Highlights for Investment Managers

Alison Conley · Posted on: July 23rd 2025 · read

Following the announcements made last month, the UK government has released draft legislation (21 July 2025) detailing the reform of the tax treatment of carried interest.

Part of Finance Bill 2025-26, the draft legislation outlines the new regime effective from 6 April 2026. Investment managers have just over eight months to prepare for these changes which are summarised below.

Key Provisions of the Draft Legislation

Meaning of Carried Interest: The meaning of carried interest as detailed in the draft legislation, largely mirrors the definition under the Disguised Investment Management Fee (“DIMF”) rules.

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Expanded Definition of Investment Scheme: The definition is extended to include an AIF, within the meaning of regulation 3 of the Alternative Investment Fund Managers Regulations 2013.
Revised Tax Treatment: Non qualifying and qualifying carried interest (see below) will be taxed on an individual as trading profit, subject to income tax and Class 4 NICs.

“Qualifying” Carried Interest The extent to which carried interest is qualifying depends on the average holding period of the investment scheme (40 months or more to be 100% qualifying). Of the qualifying carried interest, 72.5% will be counted as taxable trading profit, resulting in an effective tax rate of 34.075% for top-rate taxpayers, an increase from the 32% rate currently in effect (28% prior to April 2025). Carried interest which is not 100% qualifying carried interest may be treated as such if certain conditions are met.
“Non-Qualifying” Carried Interest Carried interest that does not meet the qualifying criteria (e.g. from shorter holding periods) will be taxed in full as income (akin to management fees). Consequently, non-qualifying carry could face a tax rate of up to 47% at the highest income tax and NIC rates. This is likely to encourage longer term investment holding periods.
Permitted Deductions The amount of money consideration given by an individual wholly for the entitlement to the carried interest, can be deducted from the amount treated as deemed trading income, less any consideration deducted in an earlier period.
Income-Based Carried Interest (IBCI) Rules Extended The existing IBCI rules will now be known as the Average Holding Period (AHP) condition and will extend to employees and LLP members. The draft legislation also includes a number of amendments to the AHP condition covering direct lending funds, bespoke credit funds, fund of funds and unwanted short term investments. These amendments address some of the complexities in how different fund types calculate average holding periods.

Territorial Scope and Non-UK Residents: As carried interest will be treated as compensation for services, non UK residents will be subject to tax on services performed in the UK. To make this more manageable, there are 3 noted exclusions which will apply to short term visitors:
- Services performed before 30 October 2024 are grandfathered.
- A non-UK resident fund manager will be subject to UK tax on carried interest only if they work at least 60 days in the UK during the tax year.
- After three full tax years of non-residency (and staying under the 60-day threshold), any carried interest arising will no longer be attributed to UK services.
Election for Carried Interest to be Chargeable as Profits Arise

These provisions ensure that short-term visits do not inadvertently pull overseas managers into the UK tax net.

This election must be given before 31 January following the end of the relevant tax year and will allow carried interest to be treated as arising at an earlier time. This will be useful in helping investment managers to manage their tax affairs.

Implications for Investment Managers

Investment managers and carried interest recipients should be aware of several impacts:

Significantly Higher Tax on Short-Term Gains

Carried interest from shorter-term investments could now incur up to 47% tax/NICs.

Greater Compliance

Firms will need to track investment holding periods and allocate carried interest accordingly. Determining qualifying vs. non-qualifying carry will require robust data on when and how investments were made and realised. It would be advisable to start reviewing fund data now to identify which carried interest might fall under the 40-month threshold.