UK Budget: carried interest tax rate increased to 32% with further increases expected from 2026

The increased tax rate will be an interim measure ahead of full reform for the tax regime for carried interest, which will be completed by April 2026, according to documents published alongside Reeves’ speech.

Peter Morley, tax expert at Pinsent Masons, said: “Today’s announcement will likely be greeted with a mixture of relief and caution by the investment funds industry – relief that the anticipated rise in tax rates was limited to 4% and caution about the impact of more sweeping reforms coming into force in 2026.”

The government intends to introduce a new regime for carried interest to ensure that carried interest is taxed within the income tax framework. The proposals for reform were outlined in a response document (28-page / 180KB PDF) to the government’s call for evidence on the taxation of carried interest published in July. The government considers that the new regime will be simpler and fairer, “ensuring that fund managers pay their fair share of tax while recognising the importance of preserving the UK’s competitive position as a global asset management hub”.

Funds tax expert Hatice Ismail of Pinsent Masons said: “Under the proposed new regime, essentially, all carried interest will be treated and taxed as trading income – at rates of up to 45% plus Class 4 National Insurance contributions – with scope for certain ‘qualifying carried interest’ to be subject to a lower effective rate of income tax, based on only 72.5% of it being subject to tax at the individual’s marginal rate of tax.”

“For additional higher rate taxpayers this would give rise to an effective tax rate of 32.625% plus NICs,” she said.

Carried interest refers to the performance-related rewards received by fund managers, primarily in the private equity industry. Unlike other rewards, carried interest can currently be taxed at lower capital gains tax rates, compared with income tax rates of up to 45%. The government believes that the current tax regime does not accurately reflect the economic characteristics of carried interest or the risk assumed by fund managers.

The proposed new rules will apply equally to employee and self-employed fund managers. Additional conditions may be imposed for carried interest to qualify for the lower effective rate of income tax. For example, a minimum amount of co-investment may be required and there may need to be a minimum period between award of the right to receive carried interest and receipt of payouts of carried interest. The government is consulting on the design of these conditions until 31 January 2025.

No other tax charge will apply to carried interest. The government considers that this will represent a major simplification of the existing tax rules, removing the complex interaction between ordinary tax principles and statutory overlays.

“Although there will no longer be any need to undertake the often-complex exercise of determining the underlying nature of the sum received, since it will all be deemed trading income, the ‘income based carried interest’ rules are themselves complex and any further conditions the government overlay for carried interest to qualify for the lower effective tax rate will add back complexity,” Ismail said. “Notably, the changes do not appear to impact the tax treatment of co-investment, with the effect that managers may be encouraged to increase any co-investment that they make going forward.”

The government intends to establish a working group with stakeholders to explore points of technical detail, with draft legislation being published during 2025.

“It is positive that the government accepts the complex nature of the tax rules for carried interest and has heeded advice from industry that the introduction of a new tax regime should not be rushed – today could have been a lot more dramatic,” said Morley.