UK Carried Interest: Key Legislative Updates

On 4 December 2025, the UK Government published the Finance Bill, which contains updated draft legislation relating to carried interest. On the same date, HMRC published an overview of the carry legislation, and draft Guidance addressing the double tax treaty implications of the revised regime. 

We are pleased to note that several recommendations put forward by DLA Piper have been incorporated into the amended legislation. Further details are set out below.

 

Key changes

• Territorial tail: under the revised regime, carried interest will be treated as profits of a deemed UK trade and taxed at a reduced income tax rate of approximately 34.1%. Consequently, carry holders who spend time working in the UK may be subject to UK tax on their carried interest with respect to their “UK Workdays", even after leaving the UK.
  
  The legislation provides three statutory exclusions which specify that the following are not treated as UK Workdays:   
  
  -any UK Workday prior to 30 October 2024;
  -any UK Workday during a tax year in which there are fewer than 60 UK Workdays in total; and
  -any UK Workday completed before a period of three or more ‘non-UK tax years’ (a non-UK tax year is defined as a year in which the individual is non-resident and has fewer than 60 UK Workdays).
  
  These exclusions apply only if the carried interest satisfies the Average Holding Period (AHP) test – broadly, the fund holds its assets by weighted average for more than 40 months. A concern we raised with HMRC is that, in many cases, it will be unclear whether future carry will qualify, as this determination often depends on decisions made by the management team at a later stage, typically in connection with an exit. As a result, overseas carry holders may be discouraged from spending time in the UK, even when such time would otherwise fall within the statutory exemptions.
  
  HMRC has partially addressed this concern in the updated legislation. If it was “reasonable to assume”, at the time of the first UK Workday, that the AHP test would ultimately be met, a non-UK individual can benefit from the aforementioned fewer than 60 UK Workday threshold. Although not expressly clarified, we expect HMRC will require some level of evidence to demonstrate that it was reasonable to assume the carry would qualify.    

• Unilateral double tax relief: a key concern under the new carry proposals is the risk of double taxation. Managers who leave the UK within three years of receiving carry (one of the statutory exclusions) could be subject to tax in both the UK and their new country of residence.  HMRC recognises this risk, and in their new draft Guidance reiterate that the UK should have primary taxing rights under the appropriate Double Tax Treaty (DTT), although it is likely that other tax authorities would disagree with this. The Guidance acknowledges that under most DTTs, an individual can only be subject UK tax on profits of a trade to the extent that they have a UK permanent establishment (PE). Such a PE is unlikely to arise through a dependent agent; rather, it would likely arise by virtue having a ‘fixed place of business’ in the UK. This is a question of fact and will be determined on a case-by-case basis.  HMRC suggest that the use of a UK place of business on a short-term and temporary basis (for example a one-off posting to the UK for a period of less than six months) is unlikely to have the necessary degree of permanence to create a PE.
  
  The updated legislation introduces a new provision allowing taxpayers resident in jurisdictions without a UK DTT to credit overseas capital gains tax against UK tax payable on carry. In practice, this is expected to have very limited application, given the UK’s extensive treaty network and the fact that many offshore jurisdictions do not impose such taxes.
  
  
• Trading profits election: The updated legislation introduces an option for individuals to elect for carried interest to be taxed on ordinary trading principles rather than under the new carry regime. While this election would subject carry receipts to a higher tax rate (45% as compared to circa 34.1%), it may be advantageous for those who would prefer to be taxed on an ordinary trading basis and thereby benefit from the more generous deductions, as compared to the more limited permitted deductions rule under the carry regime. Notably, the inclusion of this provision implies that, where no election is made, carried interest comprising trading profits on ordinary principles can still benefit from the reduced carried interest tax rate.

• UK double tax relief: As we requested, HMRC has expanded the double taxation relief provisions to cover a broader scope of UK taxes and national insurance contributions. This includes relief from taxation on dividends and corporation tax where carry is held through a company, aligning with the approach under current legislation.

• Unwanted short-term investments: As we requested, the rules on unwanted short-term investments (USTI) have been broadened and now allow for the partial syndication of a single investment (the previous draft was limited to disposals of one or more investments). This is particularly helpful in credit fund syndication strategies. In addition, USTI no longer need to be sold within 12 months, although there must still be a firm, settled and evidenced intention to dispose of the investment within 12 months. A USTI cannot exceed 50% of the total value invested in the relevant transaction.

 

Funds of funds

Various changes have been made to the provisions which apply to funds of funds (FoF), the most significant of which are as follows:

• Co-investments: An FoF may now invest in “direct co-investments” (such as SMAs), provided the FoF has also invested in the main fund.
  
  
• Independence: In response to our concerns, the definition of FoF no longer requires the FoF itself to meet the genuine diversity of ownership (GDO) condition, and now extends to bespoke investment platforms and SMAs. HMRC has also clarified that sharing a third party AIFM will no longer cause two schemes to be treated as connected - an issue that we raised in our submissions to HMRC.
  
  
• Timing of acquisition: For timing purposes, a FoF is treated as acquiring an investment at the point it becomes unconditionally obliged to subscribe for a fund interest. Any conditions outside the FoF’s control should be disregarded for these purposes.

 

Credit funds

The provisions regarding credit funds have also been amended. Key changes include the following:

• Transactions not triggering a disposal: The test for when debt investments are considered not to have been disposed of has changed. Instead of focusing on whether the “risks and rewards” remain substantially the same, the legislation now refers to the “economic exposure” to the debtor group. HMRC will issue further guidance on the interpretation of this. In addition, debt-for-equity swaps and the corporate rescue exemption are now expressly referenced in the legislation.

• Wider definition of debt investment: The definition of debt investments for credit funds has been widened compared to that of other fund strategies. It now includes arrangements providing returns economically equivalent to interest, alternative finance arrangements, creditor repos and quasi repos, and manufactured interest relationships.

• Association with significant debt investments: The test for whether a debt investment is associated with a significant debt investment is now based on whether the entities are part of a consolidated group for accounting purposes, rather than the corporation tax group test. This change aligns with our comments on the draft legislation, where we questioned the appropriateness of the 75% subsidiary test and recommended referencing group consolidation principles under international accounting standards.

 

Conclusion

Many of the changes outlined above provide helpful clarifications and welcome amendments, ensuring that the new regime better reflects the realities of diverse investment strategies. However, the most significant concern remains the risk of double taxation for non-UK residents. While the widening of statutory limitations and the clarification in HMRC’s guidance (including the six-month threshold) are positive steps, in our view these measures do not go far enough.

The Finance Bill is currently under consideration by Parliament and remains subject to change, although any further amendments are expected to be relatively minor. If you would like further details or tailored advice on these developments, please do get in touch.