Carried Too Far? A Challenge to the Tax Treatment of Carried Interest in the Private Equity Industry
(2023) British Tax Review No, 1, 22-43
24 Pages Posted: 16 Mar 2023 Last revised: 21 Mar 2023
Date Written: March 10, 2023
Most private equity funds are structured as limited partnerships. Executives in the investment management team often receive an interest in the partnership — “carried interest” — which, if the fund proves successful, will frequently become extremely valuable. The private equity industry takes the position that UK resident executives’ carried interest returns are normally taxed as a capital gain, rather than as income, on the basis that the funds are typically not trading, and HMRC generally accept this. That results in a marginal tax rate of 28 per cent rather than 45 per cent. There has been considerable public discussion as to whether this is a fair result, and whether the law should be changed, with the amount of tax at stake being approximately £600 million. This article, however, takes a descriptive rather than normative approach, and queries whether capital treatment is in fact correct under current law. The conclusion is that it is not: in practice most private equity funds are buyout funds, and the nature of those funds means that in many cases it is likely that they are trading. It follows that the correct result under current law will often be that carried interest is taxed as income. If policymakers wish to preserve the status quo, then the law should be changed to specifically tax carried interest as capital. If that does not happen, then HMRC’s current practice may, in the author’s view, be ultra vires, and therefore susceptible to judicial review by a campaign group or other interested body.
Note: “This material was first published by Thomson Reuters, trading as Sweet & Maxwell, 5 Canada Square, Canary Wharf, London, E14 5AQ, in the British Tax Review as Carried Too Far? A Challenge to the Tax Treatment of Carried Interest in the Private Equity Industry  B.T.R., No.1 and is reproduced by agreement with the publishers”.
Keywords: carried interest, UK tax
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