The Labour Party manifesto promised to cease taxing carried interest as capital. At Budget, it made good on this promise, but appears to be falling short of imposing full income tax rates on carry. This will offer at least a limited comfort to the investment management industry. Although, detail is lacking, it looks like carry will instead be taxed in the longer term at 34.1% factoring in national insurance ("NI"), which is unclear). No exemptions have been offered, such as a much speculated upon co-investment safe harbour, but as full implementation is delayed to April 2026, there is potentially still scope for this to change.
As an interim measure, the current regime will continue to apply until April 2026 with rates of capital gains tax increased to 32% from April 2025. From April 2026 carry will be taxed within the "income tax framework, with a 72.5% multiplier applied to qualifying carried interest". There is much here that is unclear, not least what will constitute "qualifying carried interest" or how this will interact with the NI regime. Taken at face value this would give an effective rate of 34.1% (72.5% of the additional rate of 45% and 2% NI).
To what extent the investment community is able or willing to absorb this rate increase remains to be seen. There had been widespread fears that this change (together with the changes to non-UK domiciled individuals rules also announced today) would see an exodus of PE houses from London. A comparatively modest 4% rise may be low enough to prevent this but this will remain to be seen. These changes may even yield a better rate for managers of credit funds, currently taxed at 45%.
In the meantime, it will be essential for those in the industry to keep an eye on detailed legislative proposals as these become available. The definition of qualifying carried interest is likely to be key, as investment managers may be able restructure either their funds or their portfolios either to fall inside or outside this definition (depending on which turns out to be more beneficial) in advance of the changes.
