Britain just stopped calling it a gain. America still does

Figures relate to tax year 2025-26 (UK) · 2025 (US)

Carried interest was always the odd one out. You put in very little capital, you took a share of the fund's profit, and both countries let you call that share a capital gain rather than pay for doing a job.

Britain has changed its mind. Carry is moving into the income tax regime, with a mechanism that treats it as trading profit rather than as a gain on an investment. America has not followed. It still treats most carry as a long term capital gain, provided the fund held the underlying assets long enough.

For an American working in a British fund, that divergence is the whole story. Two systems that once broadly agreed now differ on character, on timing, and on which country collects first.

Key takeaways

• Britain is moving carried interest into the income tax regime.
• America still treats qualifying carry as a long term capital gain.
• America applies a three year holding test before that rate is available.
• A character mismatch can strand foreign tax credits in the wrong basket.
• Timing differences can push tax into different years on each side.
• National Insurance and self-employment tax both need checking.
• The fund's own structure drives most of the answer.

What is carried interest?

It is the share of a fund's profits paid to the people who manage it, normally around twenty per cent once investors have received an agreed return. According to HMRC guidance, it is the performance-linked return on an interest in the fund rather than a fee for services.

That framing is what gave carry its favourable treatment for decades. You hold a genuine interest in the partnership, that interest produces a return, and a return on an interest looks like an investment gain rather than pay.

Both countries have spent years deciding whether they still believe that. Britain has now largely concluded that they do not, and has built a regime that taxes carry as income while preserving some of the structure around it.

What has changed in Britain?

Britain is bringing carry within the income tax regime instead of taxing it as a capital gain. The mechanism treats qualifying carried interest as profits of a deemed trade, which means income tax rates and a National Insurance charge in place of the old capital treatment.

An interim step raised the capital gains rate on carry to 32 per cent from April 2025, ahead of the full move. The direction of travel has been clear for some time, and the Treasury published consultation drafts well in advance.

There is relief built in for genuinely long-held investments, so the regime is not a flat reclassification of everything. The detail turns on how long the fund held the underlying assets and on the terms of your own entitlement.

What does America still do?

America still treats carried interest as a capital gain, subject to a holding period test. Where the fund held the underlying asset for more than three years, your share qualifies for long term rates. Where it did not, the gain becomes short term and attracts ordinary rates.

That three year rule was the American response to the same political argument Britain has now answered differently. Rather than reclassify carry as income, America lengthened the holding period needed to get the preferential rate.

The practical effect is that American treatment depends on the fund's investment horizon. A buyout fund that holds companies for five years usually clears it. A fund trading more actively often is not.

A worked example

The figures below are illustrative. They use round numbers so you can follow each step and substitute your own.

Daniel is American and works for a private equity house in London. His carried interest entitlement pays out £500,000 in a year when the fund exits a company it has held for six years.

Britain taxes that £500,000 as income under the new regime, at 45 per cent plus a National Insurance charge. Call the British tax roughly £235,000 in round terms.

America treats it as a long term capital gain, because the fund cleared the three year test. At 20 per cent plus the 3.8 per cent investment income surcharge, the American tax is about £119,000 before any credit.

The British tax is higher, so a full credit should wipe out the American charge. The difficulty is that the credit has to sit in the right category. British income tax paid on something America calls a capital gain does not always land where you need it.

Why does the character mismatch matter?

Because foreign tax credits only offset income of the matching type. America sorts foreign income into baskets, and tax paid on income in one basket cannot relieve tax on income in another, however much of it there is.

Where Britain charges income tax and America sees a capital gain, the credit can end up in the wrong place. You can pay substantial British tax and still owe American tax on the same money. That is the opposite of what a treaty should produce.

Our guide to Form 1116 income baskets explains how the categories work. For carry, getting the basket right is usually worth more than any other single decision on the return.

The two regimes compared

The table sets out where each country now stands. Both are moving, so the position is worth rechecking each year.

Does the three year test use the fund's holding period?

It does, and that is the point people most often get wrong. The clock runs on how long the fund held the underlying asset, not on how long you have held your carry entitlement or worked at the firm.

So a manager who joined last year can still receive long term treatment on an exit from a company the fund bought six years ago. The reverse is also true, and length of service earns you nothing on its own.

That makes the fund's deal-by-deal history the document you actually need. A single payment can cover several exits with different holding periods, each needing its own characterisation.

What about National Insurance and self-employment tax?

Both become live once carry is income rather than a gain. The British regime brings a National Insurance charge with it, and America may treat partnership income connected to services as subject to self-employment tax.

The protection here is the social security agreement between the two countries, which stops you paying into both systems at once. Which one you pay into depends on where you work and on whether a certificate of coverage is in place.

Our guide to the certificate of coverage covers how you obtain one. It is worth sorting before a large carry payment rather than after.

Does the fund's structure change the answer?

Considerably. Most British funds are limited partnerships, and both countries look through them. You therefore pay tax on your share of the underlying profits rather than on a distribution from an opaque company.

Where a corporate vehicle sits in the chain, the analysis changes and extra American reporting can arrive with it. A manager holding an interest in a non-British company may pick up filing duties that have nothing to do with the carry itself.

Ask for the structure chart early, because the reporting on carried interest follows the chart rather than the economics.

What about co-investment alongside the carry?

Co-invest is a different animal and usually a simpler one. You put real money in on the same terms as investors, so the return is an ordinary investment return and both countries treat it as a capital gain.

Keeping the two apart on paper is what matters. A single statement showing one combined figure makes it very hard to argue later that part of it was co-invest rather than carry.

Ask the fund to report the two separately from the start. Most will, and the ones that will not are worth pressing.

When is the tax actually due?

At different moments in each country, which is the second mismatch after character. Britain taxes carried interest when the entitlement arises under its own rules, and America taxes your share of the fund's gain when the fund realises it.

Those two dates often fall in different tax years. A credit claimed in the wrong year is no credit at all. Map the timing before you file either return.

The mismatch is worst around a fund's final exits, when several years of entitlement can crystallise at once. Plan the sequence rather than discovering it afterwards.

Does moving countries help?

Less than people hope, because carry usually attaches to work you performed while in Britain. Leaving before a payment does not detach the income from where you earned it, and both countries have rules designed to catch exactly that.

Citizenship also follows you. An American remains taxable on worldwide income wherever they live, so moving changes the British position far more than the American one.

In our practice the managers who gain most plan a move years ahead against the fund's exit timetable, not in the year a carried interest payment lands.

Does carried interest affect your pension allowance?

It can, now that Britain treats it as income. A large carry payment counts towards the threshold that tapers the annual allowance, so a manager who normally contributes fully can find the allowance cut to the minimum in a payout year.

The taper bites hard at the top. Once adjusted income passes the threshold, the allowance falls away quickly and contributions above it attract a charge.

Carry forward can rescue some of it, using unused allowance from the three previous years. Check the position before the payment rather than after.

What about a management fee share?

That has always been plain income in both countries, and nothing in the new regime changes it. A share of the management fee is pay for services, taxed at ordinary rates wherever you sit.

The useful consequence is that fee income sits in the general basket on an American return. That is where British income tax on carry may now also belong, which can help rather than hinder.

Most funds report the three separately once you ask them to.

Keep fee income, carry and co-invest as three separate lines. Each behaves differently and each needs its own treatment.

Is there any relief for long-held investments?

Yes, and it is the main softening in the British regime. Carry linked to assets the fund held for a long period keeps better treatment than carry from rapid turnover, which preserves part of the old distinction.

The American three year test does something similar from the other direction. Both systems now reward patient capital and penalise quick flips, even though they express it through different mechanisms.

Ask the fund where its average hold period sits before you model anything.

A fund with a long hold strategy therefore has the easier cross-border position of the two.

What records do you need?

The partnership agreement, the carry schedule showing your entitlement, and a deal-by-deal breakdown giving the acquisition and exit date for every asset in the payment. Those three answer nearly every question either authority will ask.

The deal-by-deal breakdown is the one funds supply least readily and you need most. Without it you cannot apply the three year test, and the default assumption is not in your favour.

Request it at the time of each distribution. Reconstructing holding periods for a fund that wound up years ago is close to impossible.

How to report it

1. Get the deal-by-deal breakdown behind each carry payment.
2. Record the fund's acquisition and exit date for every underlying asset.
3. Apply the three year test to each exit separately.
4. Split the payment between long term and short term accordingly.
5. Separate any co-investment return from the carry itself.
6. Convert each component to dollars at the rate on its own date.
7. Work out which credit basket the British tax belongs in.
8. Map the British and American taxing dates before filing either return.

Mistakes and penalties we see with carried interest

The first is applying the three year test to your own holding rather than the fund's. The clock runs on the underlying asset, and getting this backwards changes the rate on the whole payment.

The second is assuming a high British tax bill automatically cancels the American one. It only does so if the credit lands in the right basket, and with carry it often does not.

The third is treating one payment as a single item when it covers several exits. Each underlying disposal needs its own characterisation and its own date.

The fourth is letting co-invest and carry arrive as one combined figure. Once the paperwork mixes them, separating them later becomes an argument rather than a calculation.

How US UK Tax Accountants helps

We work from the deal-by-deal data rather than the summary, apply the three year test exit by exit, and settle which basket the British tax belongs in before you file. Then we map the two taxing dates so the credit lands in a year you can actually use it.

Where an earlier return used the summary figure alone, we look at whether an amendment improves the position. Our US federal return service covers the filing.

If you hold carry in a British fund and file in America, get in touch before the next distribution. Most of the value here is in the preparation rather than the return.

Last reviewed 9 October 2026. This article is general information and not personal tax advice. Every fund turns on its own documents, so take advice on yours before filing.