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UK chancellor Rachel Reeves has announced long-anticipated reforms to the taxation of carried interest, the share of profits private equity executives get to keep when they exit investments.
How will taxes on carried interest change?
In her Budget on Wednesday Reeves set out a two-pronged approach. From April 2025 the tax rate on carried interest will increase to 32 per cent, from the current rate of 28 per cent.
But from April 2026, the Labour government is proposing a bigger change. All carried interest would be taxed as income, replacing a long-standing approach that currently treats it as a capital gain.
By doing so, Reeves can say she has kept her election manifesto promise to close the “loophole” whereby private equity is “the only industry where performance-related pay is treated as capital gains”.
The new system would still treat buyout profits favourably however — carried interest that meets certain conditions would only be taxed at 72.5 per cent of the income tax rate, plus national insurance.
The result, according to the Office for Budget Responsibility, would be an effective marginal tax rate of 34.1 per cent for additional-rate payers. This compares with a top income tax rate of 47 per cent including national insurance.
Yash Rupal, head of UK tax at law firm Simpson Thacher & Bartlett, which has a prominent private equity practice, said that using this discount allowed the chancellor to say the government was “meeting its promise to tax carried interest as income while also handing an olive branch to the PE industry”.
The industry had feared that Reeves, who once branded private equity executives as asset-strippers, was planning more radical reform and would tax all carried interest at the top income tax rate of 45 per cent.
But a well-resourced lobbying effort, led by the British Private Equity & Venture Capital Association, argued that the industry had a positive impact on the UK economy and that carried interest differed from regular performance bonuses — which appears to have got through to Reeves.
Buyout managers reacting to the Budget news expressed caution. A senior partner at a large British firm said the proposed reforms were “nominally . . . very sensible” but that “the danger is that the devil is in the detail”.
A top executive of a large European buyout firm with operations in London said that while it was “not a lights out moment” triggering lots of executives to leave the UK, “going from 28 to 34 is a fair amount, some will be fine with that, but others might say, ‘It crystallises our decision to make a change’”.
What other reforms is the government considering?
The government is planning a consultation on the proposed 2026 reform to treat all carried interest as income.
It is also looking at introducing a new minimum waiting period for a fund manager to qualify for the new discounted income tax rate. Managers are currently required to wait about 40 months between the carried interest being awarded and being paid out for it to be treated as capital gains.
Before the Budget Reeves also suggested she could bring in a minimum requirement for the amount of their own cash managers must put at risk in their funds — as is required in France and Italy.
But the government now says it “would be difficult to implement” a co-investment requirement for individuals, although it is still considering such a measure at a team level.
What is the private equity industry worried about?
Some private equity executives expressed concern about another proposed government measure: a plan to apply UK income tax to carried interest received by fund managers living abroad, if it was earned on funds they managed while living in Britain.
It would be “big news” if someone living in a low tax jurisdiction such as Milan or Monaco could be hit with UK tax on carried interest relating to work they had previously done in London, said the executive of the European private equity firm, adding this prospect could discourage people from pursuing buyout careers in Britain.
One City lawyer said this measure was designed to stop egregious cases of people accruing “£30mn of carry in the UK and then leaving” without paying tax. He added that the proposal, and the general move to treat carried interest as income at a preferential rate, would bring the UK in line with Germany and Spain.
Overall, the collective sense in the buyout industry appears to be that the proposals could have been far worse.
“We think it is a sensible route forward,” said Damien Crossley, a tax partner at law firm Macfarlanes who advises private capital managers. “There is detail to work through but the proposal should result in a regime from April 2026 that is simpler than the current regime but also one which is coherent and we hope stable.”
