Tax Reform in the Private Equity Sector: Reeves Takes a Moderate Approach

The British Finance Minister Rachel Reeves has announced an overdue reform of the taxation of "carried interest" as part of her new budget plan. These are the profit shares that private equity executives are allowed to retain upon exiting investments. Starting in April 2025, the tax rate for "carried interest" will be increased from the current 28 percent to 32 percent. A year later, from April 2026, the Labour government plans a more comprehensive reform: the entire profit participation will then be taxed as income, replacing the previous approach of treating it as capital gains. Reeves can thus fulfill her election promise to close the "loophole" that allowed private equity as the only industry to declare performance-based compensation as capital gains. However, the reform remains advantageous for the industry: Under certain conditions, "carried interest" will only be taxed at 72.5 percent of the income tax rate plus social contributions. For high-earning performers, this means an effective marginal tax rate of 34.1 percent, according to the Office for Budget Responsibility. This contrasts with a top tax rate of 47 percent, including social contributions. Yash Rupal, head of the UK tax department at Simpson Thacher & Bartlett, noted that this discount allows the minister to both uphold her promise to tax "carried interest" as income and accommodate the private equity industry. There was significant concern that Reeves, who had previously referred to private equity executives as "asset strippers," might take even more radical measures. However, a well-organized lobbying campaign, led by the British Private Equity & Venture Capital Association, successfully argued that the industry makes a positive contribution to the UK economy. However, managers of private equity companies reacted cautiously to the budget news. While some described the proposed reforms as "very reasonable," concerns remained that "the devil is in the details." The government initiative also includes the introduction of a consultation phase on the planned 2026 reform and considers other adjustments such as a minimum holding period for tax benefits and the introduction of co-investment requirements for team managers. Furthermore, some private equity managers expressed concerns regarding the proposal to impose British income taxes on fund managers living abroad if they draw on returns from UK-sourced funds. This could have significant implications for those in low-tax countries like Milan or Monaco. Some experts see this as an attempt to prevent cases where managers accumulate large amounts in the UK and then leave the country without paying taxes. This strategic adjustment is also intended to align the UK system with Germany and Spain. Overall, the industry feels that the reform proposals were milder than feared. "We consider this a reasonable path forward," commented Damien Crossley, tax partner at the law firm Macfarlanes.