HM Treasury and HMRC have published 48 pages of draft legislation confirming that carried interest will be fully brought into the income tax regime from 6 April 2026. This follows an extended consultation process and reflects HMRC’s position that carried interest is “a reward for investment management services performed,” rather than a return on capital.

While the draft legislation is broadly consistent with earlier announcements, it does provide some useful clarifications and practical issues for general partners (GPs) and their deals teams to consider.

What are the key changes for carried interest tax?

• From 6 April 2026, carried interest in the UK will be taxed as deemed trading profits, subject to income tax and class 4 NICs, rather than taxed based on the underlying investment return. However, “qualifying carried interest" will benefit from a 72.5% multiplier, reducing taxable trading income and resulting in an effective tax rate of 34.1%.
• Qualification depends on the fund’s weighted average holding period, calculated under new “average holding period” (AHP) rules, which are based on the existing income-based carried interest (IBCI) regime. While the AHP rules are improved, some aspects remain complex in practice.
• The new rules also apply to non-UK residents, but qualifying carried interest is taxable only to the extent it is attributable to UK workdays, with some helpful limitations regarding what counts as a UK workday. Tracking "workdays" will likely raise practical challenges and debate.
• The draft legislation leaves carried interest as part of adjusted income for the purposes of pension annual allowance tapering. This increases the complexity of individual tax compliance, as well as the risk of pension tax relief claw backs.
• Carry is also forms part of the calculation of payments on account (PoA). Including such unpredictable income may lead to underpaid PoAs, interest charges and the possibility of cash flow pressures.

What is carried interest?

Carried interest is a share of variable fund profits for investment managers that arise after investor hurdles are met. The legislation maintains this definition.

The timing of taxation remains unchanged: by default, income tax will be charged in the tax year in which sums arise (i.e. when the profits out of which the carried interest is paid are realised). The draft legislation also retains the existing deeming provisions, meaning that indirect allocations, for example, via connected companies or trusts, are treated as taxable on the relevant executive at the point those sums arise, limiting deferral opportunities.

A welcome clarification is the inclusion of specific provisions for the treatment of tax distributions within the legislation. This aligns with current HMRC practice and is a notable improvement to the existing framework, as it provides greater certainty.

Rules relating to the definition of investment management services are preserved in broadly similar form, the exclusion of co-investment from the carried interest regime (where capital is genuinely at risk), relief for UK double taxation via consequential adjustments, and deferred taxation where (for example) the proceeds from an investment are held in escrow pending certain conditions being met. However, one key extension is the broadened definition of an “investment scheme”. This now explicitly includes alternative investment funds (AIFs) alongside collective investment schemes (CISs), ensuring the regime captures a wider range of fund structures.

How will carried interest be taxed from April 2026?

The most significant change is the expected shift to income tax treatment. From 6 April 2026, all carried interest will be taxed as trading income, subject to income tax rates of up to 45% plus (normally) 2% national insurance contributions (NIC).

This reflects the government's view that carried interest is a reward for services performed and not a return on investment.
However, the government have acknowledged that there is a need to maintain the UK's competitiveness in the global fund management industry, and recognising the central role of carried interest in this, the government will apply an income-reducing multiplier.

Under this mechanism, only 72.5% of the 'qualifying’ profits will be treated as trading income, resulting in effective tax rate on the ‘qualifying’ carried interest receipt of 34.075%.

For example:

Key draft legislation changes

AHP replaces IBCI

• “Qualifying” is the important term here. Qualifying status is now determined by the weighted average holding period (AHP) of underlying fund investments. This replaces the current income-based carried interest (IBCI) rules, though it is conceptually very similar.
• The regime retains the familiar 40-month threshold; carry linked to investments with AHP of 40 months or more qualifies in full for the 72.5% multiplier.
• A tapered relief applies between 36 and 40 months.
• Carried Interest receipts arising from investments with an AHP below 36 months will not benefit from the multiplier.

Special provisions for different fund types

• Direct lending funds: the current rule that automatically disqualifies carried interest from satisfying the AHP condition in the context of direct lending funds, unless an exemption applies, will be removed.
• Bespoke credit fund provision: a new provision will apply to credit funds, under which both debt investments and associated equity instruments will be treated as acquired and disposed of at prescribed times.
• Funds of funds and secondary funds: the existing rules will be consolidated and replaced with a single provision that applies to both fund of funds structures and secondaries.
• Unwanted short-term holdings: the scope of the short-term investment rule will be broadened. It will now apply in a wider range of situations where an investment is disposed of within 12 months, provided the intention was not to hold it long-term and certain conditions are met, including that any profit realised on disposal does not significantly influence the potential for carried interest to arise.
• Scheme director condition: the existing scheme director condition that is relevant to the assessment of the AHP condition for venture capital and significant equity stake funds will be replaced with a broader test that considers whether the fund has the rights a prudent investor would obtain in relation to the conduct of the investee’s business

Implications for non-UK residents

Under the current rules, non-UK tax residents are not taxed on carry receipts. However, from 6 April 2026, non-UK tax residents will be subject to UK tax on carried interest to the extent it is attributable to investment management services performed in the UK after the date of award of the carry. However, following industry consultation, HMRC has included three statutory limitations under which certain UK workdays will be treated as non-UK workdays if the recipient is non-UK resident in the tax year in which the carried interest arises.

• Pre-30 October 2024 UK workdays: any UK workdays performed before 30 October 2024 will be treated as non-UK workdays.
• Fewer than 60 UK workdays in a tax year: UK workdays in any tax year during which the individual is non-UK resident and performs fewer than 60 UK workdays will be disregarded.
• UK workdays prior to an extended period of non-residence: UK workdays performed before a continuous period of three or more years in which the individual is non-UK resident and has fewer than 60 UK workdays will also be treated as non-UK workdays.

Tax treatment of temporary non-UK residents

In addition, the draft legislation includes provisions addressing individuals who were temporarily non-UK resident during the 2025‒2026 tax year or earlier. Where a carried interest gain accrued during a period of temporary non-residence, the individual will, upon their return to the UK, be treated as carrying on a trade in that tax year, with 72.5% of the carry subject to UK tax as deemed trading income.

Double taxation and treaty relief

Where carried interest is subject to tax both in the UK and in another jurisdiction, relief from double taxation will typically be sought under the applicable double tax treaty. HMRC’s view is that Article 7 (Business Profits) will generally apply in these cases, meaning the UK will have primary taxing rights. As a result, any relief for UK taxes should ordinarily be claimed in the other jurisdiction. As is currently the position, relief for any overseas taxes is not available via the consequential adjustment for UK double taxation referred to above.

Option to elect for accruals basis

The draft legislation retains the option to elect for carried interest to be taxed on an accruals basis, where the fund’s unrealised gains exceed the relevant hurdle. This election remains valuable in certain circumstances, particularly for US citizens who are subject to US tax on worldwide income and gains, including carried interest, in tax years before any cash distributions have been received.

Cash flow challenges

The draft legislation does not exclude carried interest from being included in adjusted income for the purposes of pension annual allowance tapering, or in the calculation of income for payments on account (PoA). This omission increases the complexity of individual tax compliance, as well as the risk of pension tax relief claw backs and interest charges on underpaid PoAs, leading to potential cash flow pressures.

Pension tax pitfalls under the new carried interest rules

Under current rules, the standard £60,000 annual pension contribution allowance is tapered down to £10,000 where an individual’s adjusted income exceeds £260,000.

Historically, carried interest, when taxed as capital, did not count toward adjusted income and therefore did not affect tapering. Under the new rules, however, carried interest taxed as trading income will be included, potentially causing unexpected tapering, particularly where carry is received late in the tax year, after pension contributions have already been made.

This can trigger a punitive 45% tax charge on excess contributions, clawing back the pensions tax relief which would have been received at source.

Example: pension tax charge triggered by year-end carry

• Salary and bonus: £250,000.
• Pension contributions: £1,875 per month gross (total £22,500 annually).
• Carried interest: £150,000 (received in March 2027).

In this scenario, the £22,500 pension contribution would normally fall well within the £60,000 annual allowance. However, once the £150,000 carried interest is received, adjusted income rises to £400,000, reducing the annual allowance to just £10,000.

This creates an excess contribution of £12,500, subject to a 45% claw back charge, resulting in a £5,625 personal tax liability via self-assessment (assuming no brought forward allowances). This charge must be paid in cash, and pension funds cannot be used to settle it.

Payments on account complexity

Under the new regime, income tax and Class 4 NIC paid in the previous tax year on carried interest will be relevant to the calculation of payments on account. Consequently, careful cash flow management will be essential for individuals in receipt of carried interest.

There are two key pitfalls to be aware of when managing payments on account:

• Scenario one ‒ the individual has excessively reduced their payments on account based on an expectation of lower carried interest income, but actual income exceeds projections. This results in underpaid tax and interest charges from HMRC.
• Scenario two ‒ the individual opts not to reduce their payments on account, anticipating similar carried interest income in the following year. However, no carry payment is received (a deal aborts or is delayed), resulting in an overpayment to HMRC and lost opportunity for returns on that capital.

Proper planning and accurate forecasting are therefore critical to minimise unnecessary interest charges and optimise use of available funds.

An early evaluation of the implications of Making Tax Digital (MTD) is also advisable. From 6 April 2026, carried interest is expected to fall within the scope of MTD, as it will be treated as trading income. This will require individuals to submit quarterly updates to HMRC detailing their trading profits. Although some aspects of MTD are still being finalised, HMRC’s current intention is for the regime to take effect as planned.

By proactively addressing these developments, finance teams can better prepare their firms for the transition. This will support compliance, enhance operational efficiency, and ensure alignment with broader strategic objectives.

What should you do now to prepare for carried interest tax changes?

Consultation on the draft legislation runs until mid-September 2025, after which final rules will be included in the Finance Bill likely to be introduced following the Autumn Budget. The publication of the draft legislation marks the start of a final transitional window before the new regime takes effect on 6 April 2026.

During this transitional period, actions that many firms will be considering include:

• Reviewing fund, deal, and carried interest structures, as legacy arrangements may no longer deliver the intended outcomes under the new rules.
• Reviewing upcoming exits and modelling the impact of the AHP test and implementing robust tracking of holding periods.
• Assessing the position of globally mobile individuals, including current key personnel and potential future inbound hires, to understand how the UK tax landscape will affect them both during and after their UK tenure.

Please do get in touch with Lewis Tompkins or Paul Clark if you would like to know more about the upcoming changes and more importantly their impact on your business and team.

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