UK Carried Interest Reforms: Balancing Tax Equity With Global Competitiveness

Policy Objectives Behind the Overhaul

The Treasury’s dual mandate required balancing equitable taxation against capital retention. As BVCA Chair Michael Moore noted, reforms needed to “secure public finances while maintaining the UK’s investment pipeline”[8]. Initial 2024 proposals sought full income tax treatment but faced warnings that a 45% rate would trigger mass relocations[12][13]. The compromise 34.1% effective rate – achieved through a 72.5% taxable portion – aims to capture £480m annually[1] while keeping UK rates competitive versus France (30%) and Germany (33%)[4][12].

Key Revisions: From Prescriptive Rules to Targeted Incentives

Abandoned Measures: Co-Investment and Lock-Up Periods

Original 2024 consultations proposed requiring fund managers to maintain minimum co-investments (3% of fund size) and hold carried interest for five years[1][4]. Industry pushback highlighted how these would disadvantage emerging managers and distort compensation structures[9][10]. Final rules scrapped both conditions, recognizing that existing 40-month asset holding periods and market-driven co-investment practices already align interests[6][14]. As Akin Gump analysts observed, this removed “duplicative burdens that threatened to make UK funds unmarketable”[4].

Refined International Provisions

Non-resident managers secured critical protections against retroactive taxation. Services performed pre-October 2024 won’t trigger UK tax liability[4][12], while a 60-day annual threshold prevents transient visits from creating nexus[6][14]. These changes address “double taxation nightmares” where managers faced UK claims on carry earned years after departing[4][12]. Treasury estimates suggest 78% of non-dom managers will now fall outside the regime[14].

Implementation Mechanics: Bridging Theory and Practice

The 72.5% Multiplier: How Qualifying Carry Gets Calculated

At the regime’s core lies a novel calculation method: only 72.5% of carried interest distributions are subject to income tax and NICs[1][6]. This creates an effective 34.075% rate for additional-rate taxpayers versus 45% on ordinary income. To qualify, funds must meet existing 40-month average holding periods – a condition now extended beyond LLP members to all carry recipients[3][6]. Private credit and secondary funds gain new averaging concessions to accommodate their operational models[14].

Transition Timeline and Compliance Considerations

The phased implementation gives firms 18 months to restructure compensation plans. April 2025 sees CGT rates rise temporarily to 32%[1][5], bridging to April 2026’s full income tax shift. HM Revenue & Customs will allow carried interest accruals pre-2026 to retain capital treatment if vested by March 2026[6][14]. BDO’s Jennifer Wall notes the “critical importance of cash flow planning” given payments on account requirements tied to prior-year liabilities[14].

Industry Impact: Winners, Losers and Unintended Consequences

Emerging Managers vs Established Players

Scrapping co-investment requirements particularly benefits smaller VC firms and first-time funds lacking deep partner capital. As BVCA research shows, 62% of sub-£500m funds would have struggled with 3% co-investment thresholds[9][10]. Conversely, mega-funds like Blackstone and KKR gain clarity on cross-border tax exposure – though compliance costs may still rise 15-20% according to EQT internal projections[12].

Carried Interest vs Co-Investment Returns

The reforms create new arbitrage opportunities between carried interest and co-investment profits. With co-investments retaining capital gains treatment, firms may rebalance compensation toward direct investments. As FD Capital’s analysis suggests, this could increase co-investment allocations from 12% to 18% of partner compensation[7][14]. However, the 40-month holding requirement prevents short-term gaming[6][14].

Global Context: UK Positioning Post-Reform

Comparative Analysis With EU Jurisdictions

Despite higher nominal rates, the UK’s refined regime remains competitive. France’s 30% flat rate applies only after €1m thresholds, while Germany’s 33% includes solidarity surcharges[4][12]. Crucially, the UK’s 60-day residency rule is more generous than the EU’s 183-day standards[6][14]. As Proskauer analysts note, these “nuanced differentiators” could help London regain ground lost to Luxembourg and Amsterdam post-Brexit[3][12].

Implications for Fund Domiciliation Decisions

Early indications suggest reforms have stabilized domiciliation trends. While 23% of surveyed firms considered relocating in 2024[12], post-announcement polls show 89% expect to maintain UK operations[8][14]. The key test will be final legislation’s treatment of offshore funds with UK advisors – an area still needing clarification per Kirkland & Ellis memos[4][12].

Future Outlook: Unresolved Issues and Regulatory Risks

Pending Technical Consultations

With draft legislation due July 2025, critical details remain unresolved. Key areas include carried interest apportionment for multi-jurisdiction funds, carried forward loss utilization, and the treatment of fund restructurings[1][14]. BVCA Director General Michael Moore emphasizes that “getting the technical architecture right will determine whether this reform succeeds or backfires”[8][10].

Long-Term Policy Trajectory

While current reforms reflect industry input, the Treasury’s 2027 review clause keeps alive proposals for higher rates or broader bases. Tax Policy Associates’ Dan Neidle warns that “34% may be a stepping stone to 45% once compliance systems mature”[11][14]. Conversely, a future Conservative government could revisit the regime – though reversal seems unlikely given cross-party consensus on closing “private equity loopholes”[11][12].

Conclusion: A Delicate Equilibrium

The revised carried interest framework represents a hard-won compromise between fiscal imperatives and economic realism. By preserving core competitiveness while addressing perceived inequities, the UK has arguably struck a better balance than recent EU interventions. However, as Jennifer Wall of BDO cautions, “the devil remains in the technical details yet to be published”[14]. With global tax transparency initiatives accelerating, UK policymakers must now demonstrate that nuanced, evidence-based regulation can coexist with robust investment growth – setting a template for other jurisdictions navigating the carried interest conundrum.