Following consultation beginning in 2024 and several legislative iterations, the new UK carried interest regime is now in force for carried interest distributions made from April 2026. The new regime remains largely in line with draft legislation published in 2025 but will increase complexity for many taxpayers. This article (i) explains the final position; (ii) considers the implications for certain fund strategies; (iii) explores areas of continued tension on application to non-UK residents; and (iv) examines the cash flow and compliance consequences for carry-holders dealing with “payments on account” and “making tax digital” regimes for the first time.
Overview of the New Regime
Prior to April 2026, carried interest was treated as profits arising from investment activity and therefore taxed at rates that were based on the nature of the underlying proceeds, with rates of up to 32%, 39.35% or 45% (in 2025/26) depending upon whether the carry was distributed out of underlying capital returns, dividend income or interest income, respectively.
The core change under the new rules is that carried interest will be taxed as profits arising from a deemed trading activity and thus will fall entirely within the income tax regime and subject to Class 4 National Insurance Contributions (NICs), which are generally imposed on the self-employed. Employer NICs will not be due. This means that carry will, in principle, be taxed at 45% for additional rate taxpayers with a further 2% NIC, taking the overall top rate to 47%. However, “qualifying” carried interest (QCI) will be eligible for a partial tax exemption that reduces the taxable amount by 27.5%, resulting in an effective tax rate of just over 34%.
Whether or not carried interest is QCI will be determined by referring to the average holding period (AHP) rules based on those used in the previous income-based carried interest (IBCI) regime. In short, if a fund holds its investments for an average of at least 40 months, its AHP is therefore at least 40 months and all the carried interest is QCI. If the fund’s AHP is less than 36 months, none of the carried interest is QCI. If the AHP is at least 36 months but less than 40 months, a percentage of the carried interest will be QCI depending upon the actual AHP. The IBCI regime was limited in its scope and, importantly, did not apply to employees. Thus, the concept of calculating a fund’s AHP will be new for many carry-holders and fund sponsors.
Strategy-Specific Provisions: Credit Funds and Funds of Funds
Special provisions for the calculation of the AHP (in particular, for determining the beginning and end of an investment’s holding period) apply to different fund strategies, to reflect differences in how investments are made, held and disposed of in these strategies and enabling the fair application of the AHP rules. While these provisions are fairly intuitive to apply for certain strategies, such as buyout funds, in some other strategies, such as credit and funds of funds, sponsors are likely to encounter complexity in their AHP calculations, but may get an overall better result than under the IBCI regime.
The AHP rules for credit funds under the new regime provide that the holding period of a debt investment starts at the point a fund is unconditionally obliged to advance money, with certain prepayments and restructurings not counting as disposals (which could otherwise unduly shorten the AHP). These and certain other provisions make the regime somewhat more favorable for credit funds, since carry arising from them is more likely to be treated as QCI; under previous draft rules and the IBCI regime, carried interest arising from credit funds was often taxable at higher rates than those applicable to buyout funds.
For funds of funds and secondaries funds, the intent of the special provisions is that the investment to which the AHP is applied is treated as the relevant investee fund, rather than its underlying assets (which would make tracing the AHP very complicated). However, these categories are subject to strict entry criteria that may not always be straightforward to apply, particularly for funds that invest in a variety of deal types.
Application to Non-UK Residents
One of the key aspects, and most important challenges, of the new regime is its potential application to non-UK residents. As a matter of UK law, an individual’s “trade” (which is deemed to exist in order for such individual’s carried interest to be taxed as trading profit) will be treated as occurring in the UK, to the extent that investment management services that give rise to the carry are performed there. This may expose non-UK residents to UK tax under the usual rules relating to trading in the UK by non-residents. Fortunately, the new regime imposes some limitations on its applicability to non-residents. Most importantly, as long as an individual does not spend 60 or more days working in the UK in a tax year, QCI (or carried interest reasonably expected to qualify as QCI) will not be within the scope of UK tax.
However, this still leaves some potential issues for non-UK residents. First, the limitations do not apply to carry that is non-qualifying. Second, and more importantly, not everyone will be in a position to avail themselves of the statutory limitations—for example, those who work in the UK for a year or two (which will bring a portion of their carry into the UK tax net) and then receive a payment of carry after they return home. Absent treaty protection, the individual may be regarded as receiving profits from a trade carried on in the UK, which are subject to UK tax.
The issue of treaty protection remains a matter of contention. His Majesty’s Revenue & Customs (HMRC) takes the view that, generally, the “business profits” article applies so that, if there is a “permanent establishment” of the individual’s deemed trade, the UK has taxing rights. Many advisers disagree and take the position that a domestic deeming rule cannot be applied to a treaty, which would instead allocate taxing rights to the individual’s jurisdiction of residence. Careful advice will be required in this area.
Payments on Account and Making Tax Digital
A key cash flow implication of the new regime is that carry-holders are likely to need to make, in each tax year, advance payments on account (PoAs) of their next year’s carried interest tax liability, based on their prior year’s carried interest (and certain other income). PoAs apply to individuals for whom less than 80% of whose total income tax and Class 4 NICs liability is withheld at source (i.e., from employment income), subject to a certain de minimis threshold. Capital gains, which formed a significant proportion of carry under the previous regime, are excluded; however, deemed trading profits (under the new regime) are not excluded. Hence, many carry-holders may not have encountered PoAs before 2026/27. PoAs are due in January and July of each year, with each PoA representing 50% of the previous year’s tax liability to which PoA rules apply.
Carry-holders may find it challenging to meet PoAs that are based on the prior year’s income where that income includes carry, which is often inconsistent and unpredictable. While taxpayers can request adjustments from HMRC to the amount of a PoA, they may suffer a punitive rate of interest if that reduction turns out to have been excessive; as such, carry-holders will need to approach PoA adjustments with caution.
In addition to the carry changes, April 2026 also sees the introduction of a series of changes to tax compliance and reporting referred to as “making tax digital” (MTD). MTD for income tax requires, among other things, that affected businesses (including sole traders and hence the deemed trade of a carry-holder) keep digital records of income and expenses and report information quarterly to HMRC, as well as making a year-end submission (equivalent to their current tax return) that will include any other income, as well as their final business profit and/ or loss. Fortunately, the earliest that carry would be required to be reported under MTD would generally be April 2028, assuming carry is the only “trade” carried on by the individual; the requirement to use MTD does not commence until April after the year in which the trade is first reported in a self-assessment return. The earliest period for which carried interest will be required to be reported as trading profits is the 2026/27 tax year with the relevant self-assessment return being filed in the 2027/28 tax year (i.e., by a January 2028 deadline). It follows that the earliest date carried interest will be required to be reported using MTD for income tax is April 2028.
Conclusion: Increased Complexity
The UK’s new carried interest tax regime will pose new challenges for carry-holders and fund sponsors; international issues, in particular, are likely to be the subject of continued debate, since the UK will be an outlier in potentially seeking to tax carried interest arising to non-residents. The AHP rules, especially in relation to certain strategies, will require detailed consideration given the potential complexity of the calculations and fund sponsors will need to consider what information and assistance they provide to carry-holders to determine their carry taxation.
The topics addressed in this article highlight only a subset of the issues facing UK taxpayers under the new carry regime. Moreover, several important elements of the previous law relating to carried interest have been retained. In particular, the disguised investment management fee (DIMF) and employment-related securities (ERS) regimes will continue to apply to carry as they have previously, meaning that QCI status will be only one part of the carried interest tax analysis. The new carry regime also does not affect the taxation of UK individuals’ co-investment returns, which will continue to be treated as investment profits (and, therefore, further removed from the taxation of carried interest). Overall, the new regime may affect compliance complexity as much as tax liability.
Private Equity Report Spring 2026, Vol 26, No 1