With the start of the new tax year on 6 April, the Government has made good on its promise to close the so-called ‘carried interest loophole’ as the UK’s long-awaited changes to the taxation of carried interest are now finally in force (ITTOIA 2005 ss 23I–23R inserted by FA 2026 s 58). For many UK taxpayers in the investment management sector, the headline change will be an increase to the minimum available tax rate for carried interest – from 32% to 34.075%.
However, the new regime brings a significant number of less obvious but equally significant changes. In particular, UK tax on carried interest now extends to anyone who performs investment management services in the UK (ITTOIA 2005 ss 23I and 23K).
Historically, a non-UK resident would not generally expect to pay UK tax on their share of any carried interest receipts (subject to certain specific exceptions, such as amounts reclassified as UK taxable disguised investment management fee (DIMF) income under ITA 2007 ss 809EZA–809EZH). However, from 6 April 2026, non-residents who spend time working in the UK will now need to consider the complex new rules and, indeed, may become subject to UK tax on their carried interest returns.
Under the previous regime, the UK tax treatment of carried interest receipts generally followed the character of their source. Broadly, this meant that carried interest representing a share of capital gains realised by an underlying investment scheme would itself be taxed as a capital gain (albeit at a special higher rate of 32% under TCGA 1992 s 1H and, Part III Chapter V, now largely repealed). Likewise, carried interest representing a share of income profits would be taxed at corresponding income tax rates. This meant that the UK would impose tax on a non-UK resident’s carried interest in only two circumstances:
The new regime moves away from a source-based analysis. Instead, all carried interest is now treated for UK tax purposes as trading income.
While the IBCI rules referred to above have been abolished, they are effectively replicated under the new regime such that ‘non-qualifying carried interest’ derived from investment schemes with low average holding periods is taxed at the marginal 47% rate of income tax and self-employed NICs. For the remaining ‘qualifying carried interest’ (broadly, carried interest in respect of investments with average holding periods above certain levels), the tax charge is reduced by a 72.5% multiplier, resulting in a c.34.1% effective rate. This is the case whether the carry holder is an employee or not (in other words, the new regime abolishes the previous distinction between employees and non-employees with regard to IBCI).
For non-UK residents, the new regime follows the general principles for the territorial scope of UK taxation on trading profits – namely, that the UK will tax the profits of a trade carried on in the UK. For these purposes, the new rules will treat affected individuals as carrying on two trades: one trade carried on entirely in the UK, correlating to work done in the UK, and so subject to UK tax; and another trade carried on entirely outside the UK, correlating to work done elsewhere, and so outside the scope of UK tax. However, the process for calculating that split is not straightforward.
The new regime includes complex and prescriptive rules for calculating the proportion of a non-UK resident’s carried interest which is treated as the profits of a UK trade (ITTOIA 2005 s 23K). While a complete explanation goes beyond the scope of this article, this is broadly calculated as a fraction determined by applying the following steps:
The guardrails referred to above provide helpful limits to the extra-territorial scope of the new rules, but do not apply equally to all amounts of carried interest. The most generous protections apply to qualifying carried interest and offer three layers of protection:
For non-qualifying carried interest, the protections are comparatively slim: neither the grandfathering nor the leaver guardrail apply. The de minimis guardrail is potentially available, but only to the extent that, on the first UK workday of the relevant period, it was reasonable to expect that the carried interest in question would have been qualifying, even though this proved not to be the case (so-called ‘anticipated qualifying carried interest’).
This means that where a non-UK resident receives a mix of qualifying and non-qualifying carried interest, the taxpayer will need to apply one fraction to the qualifying portion and another to the non-qualifying portion (which itself may need to be split between anticipated and non-anticipated qualifying carried interest). Taking a step back, this also means that a non-UK resident receiving non-qualifying carried interest is potentially exposed to UK tax if they spend even a single day working in the UK, and even if that day preceded the announcement of the new regime.
As the reader will appreciate, and as illustrated by the simplified flowchart shown above, these rules are highly complex and pose a significant compliance burden for taxpayers who, before April, may have been entirely outside of the UK tax net. The legislation also includes various detailed adjustments and modifications to the principles outlined above and so it will be essential for affected individuals to obtain specialist advice.
It is equally important to keep in mind that the changes described above affect UK law only. Accordingly, where a non-UK resident is taxed on their carried interest receipts in their jurisdiction of residence, the expanded territorial scope of UK tax exposes that individual to the risk of double taxation – that is, UK tax and non-UK tax on the same amount.
Where the relevant jurisdiction has no double tax treaty with the UK, the taxpayer may be able to claim unilateral relief in the UK (broadly, providing credit for the foreign tax liability against UK tax on the carried interest). However, many taxpayers will be resident in jurisdictions which are included within the UK’s wide network of treaties and which are, therefore, subject to provisions allocating taxing rights to one particular jurisdiction and providing for double tax relief.
By way of comparison, where non-UK residents are subject to UK tax on amounts treated as DIMF (including, historically, under the IBCI regime), HMRC take the view that the business profits article of most treaties will apply; this allows the UK to retain taxing rights (and so to deny relief in the UK) to the extent the individual’s UK activities give rise to a permanent establishment (see HMRC’s Investment Funds Manual at IFM36220, with the DIMF guidance at IFM36000 et seq). While these rules are complex, this is likely to be the case if, for example, the individual works in the UK out of their firm’s UK office.
While HMRC have not yet published their intended approach to tax on carried interest for non-UK residents, the Government has indicated that it will seek to apply the business profits article on the basis that carried interest is now treated as the profit of a notional trade (effectively, the same as DIMF). Provided other jurisdictions agree with that approach, the individual’s jurisdiction of residence should give relief where they are trading in the UK through a permanent establishment, and the UK should give relief where they are not.
However, there is a risk that an individual’s jurisdiction of residence could disagree with the business profits article approach, and instead seek to apply a different article of the treaty such as the other income article, or the article corresponding to the character of the underlying fund profits. This could lead to potential conflicts where the individual’s jurisdiction of residence applies a treaty article under which it claims taxing rights. In other words, the risk is that HMRC views one treaty article as being relevant in this context but the tax authority in the individual’s home jurisdiction views a different treaty article as being relevant in this context and the two tax authorities do not agree on the treaty basis for relief against double taxation. Where such a conflict exists, treaty relief could initially be denied in both jurisdictions, leaving the individual with unrelieved double tax.
In such a situation, the individual could potentially seek to break the deadlock by arguing that HMRC would be incorrect to apply the business profits article instead of the other income article or the article relating to the underlying profits. The leading authority on this subject is the Supreme Court’s decision in Fowler v HMRC [2020] UKSC 22, which dealt with employment income of professional divers which had been recharacterised for UK tax purposes into trading profit. In that case, the court found that the treaty must be applied to the ‘real world’, rather than to the ‘fictional, deemed world’ that the recharacterisation created for UK domestic tax purposes. The question then, is whether this principle goes so far as to prevent HMRC from applying the business profits article to carried interest notwithstanding that HMRC now treats carried interest returns as trading income.
While it has never been judicially determined whether carried interest should be regarded as a reward for services or a share of an investment return, HMRC have not historically sought to treat carried interest by its inherent nature as a reward for services. For example, where an entitlement to carried interest is awarded to an employee, its value is potentially taxable as remuneration under the UK’s employment-related securities regime (ITEPA 2003 Part 7). However, HMRC historically appears to have accepted that while the value of that entitlement should be regarded as a perquisite of employment, any future payments when the carried interest subsequently pays out generally should not. The new rules therefore appear, on their face, to treat carried interest as profit of a notional trade created as a fiction for UK domestic tax purposes, rather than clarifying any ambiguity of fact. On that basis, it could certainly be argued that the principle in Fowler should apply to carried interest, such that the UK should instead apply the treaty article corresponding to the source of the underlying profit.
Alternatively, the individual could try to obtain relief in their jurisdiction of residence by reference to the treaty articles governing the elimination of double taxation, which typically provide that where a sum is treated differently due to differences in the domestic laws of the contracting states, the jurisdiction of residence is generally required to provide double tax relief. While the OECD confirms that position in its Commentary on the model convention, it goes on to specify that these articles do not oblige the jurisdiction of residence to provide relief where the conflict is one of interpretation of either fact or the articles of the treaty (see paragraph 32.5 of the OECD’s Commentary on Articles 23A and 23B, published 18 December 2017). Accordingly, there would remain a risk that an individual’s jurisdiction of residence could deny relief by asserting either that:
There are, of course, counterarguments to each of these points and so if HMRC does indeed seek to apply the business profits article to carried interest, non-UK residents taxed both in the UK and in their home jurisdictions on their carried interest will be left with uncertainty as to how easily they will be able to access relief from double taxation and, indeed, whether such relief should ultimately be sought in the UK or in their home jurisdiction. While affected individuals may be able to avail themselves of mutual agreement procedures to compel the UK and their jurisdiction of residence to resolve any such conflicts, this could be a costly and time-consuming process with no guarantee that exposure to double tax will be eliminated.
To compound this uncertainty, the position could potentially differ from jurisdiction-to-jurisdiction and, as the first UK self-assessment returns under the new regime are not due until 31 January 2028, it is likely to be a number of years before these points are tested in anger.
As a final note, while this article focuses on the implications for non-UK residents, this risk is also potentially relevant to UK resident individuals seeking double tax relief on carried interest which is taxable in another jurisdiction (for example, where carried interest represents a share of a gain on the sale of immovable property in a jurisdiction which, like many others, imposes extra-territorial tax on such profits).
In the immediate term, non-UK resident investment managers should take care to monitor their exposure to UK tax on carried interest. Looking further forward, affected individuals will need specialist advice to navigate not only the intricacies of the new UK rules and how the rules apply to their particular circumstances, but also the ongoing development of their cross-border implementation. The regime is now in force, but its practical boundaries remain untested; for internationally mobile managers, the difficult question may be not simply whether carried interest is taxable, but where, when and to what extent.
