Current position

Currently, carried interest is subject to capital gains tax (CGT) if none of the anti-avoidance provisions apply. This is based on the memorandum of understanding dated 25 July 2003 between the then Inland Revenue (now HMRC) and the British Private Equity & Venture Capital Association. The income-based carried interest (IBCI) rules treat some receipts as liable to income tax, and in some cases, national insurance contributions (NICs).  

Changes announced by the government

At the Autumn Budget 2024, the government announced the following changes to the tax treatment of carried interest:

• for 2025/26, carried interest amounts not falling within the IBCI rules will be charged to CGT at a flat rate of 32%. Currently, gains are taxed at 18% or 28% depending on the person’s income; and
• for 2026/27 onwards, carried interest will be subject to income tax and class 4 NICs as trading profits, with a 72.5% multiplier applied to qualifying amounts. The government proposes that amounts falling within the IBCI rules will not be qualifying amounts. 

At the same time, the government published a consultation on aspects of the new income tax framework for carried interest. This includes the conditions that may be required for carried interest to be treated as qualifying, including whether there should be requirements for:

• a minimum co-investment requirement; and/or
• a minimum time period between an individual being awarded carried interest and receipt.

ICAEW’s response

ICAEW believes that there is no need for a minimum co-investment requirement for tax  purposes. This is because, for most funds, investors already require the fund managers to co-invest. Therefore, it seems unnecessary to have corresponding conditions for tax purposes that might artificially distort the nature of those negotiations. Further, the test may be impractical to track in some structures; and prejudicial to those from less well-off socio-economic backgrounds, or at earlier stages of their career.

Also, ICAEW has concerns about the introduction of a minimum holding period. The IBCI rules already consider the average period that a fund holds its investments and, if that is less than 36 months, the carried interest is wholly taxable as income tax, with pro-rating between income tax and CGT for periods of less than 40 months. A minimum holding period for individual fund managers would add an additional layer of complexity and would have an impact on their job mobility.

However, if the government considers that at least one of the proposed tests is necessary, ICAEW’s preference would be for a minimum holding period. A lot of structures used by the private equity funds, especially ones with overseas/multi-national focus, may find it difficult to fit into a simple co-invest definition.

ICAEW considers that grandfathering provisions are required for existing carried interest entitlements because the level of co-investment and carried interest entitlements are governed by the partnership deed agreed at a fund’s inception and cannot be changed.

Further information

• ICAEW Representation 11/25