As private equity firms establish operations in multiple jurisdictions, the tax rules to which they are subject become substantially more complex. Among the issues such firms must deal with is the manner in which their principals are taxed on their share of a fund’s carried interest. How this issue is managed can affect the rate at which a principal’s share of carry is taxed, and in some cases, the time at which it is taxed. This article will discuss how home country tax rules affect proceedings as a typical US private equity fund adds principals in the UK, France and Germany.  

Our hypothetical US fund (the Fund), is a limited partnership, with an LLC as its GP. The carry consists of a special interest of the GP in the Fund, representing a right to receive 20 percent of its profits once the investor’s capital contributions have been returned, and any preferred return has been paid on that capital. The principals’ share of the carry is represented by an ownership interest in the GP.  

United States

In the US, compensation of individuals is subject to federal income tax at a maximum rate that is around 20 percentage points higher than the rate applicable to capital gains of individuals. Both limited partnerships and LLCs are generally fiscally transparent. Under current law, a US principal will generally not be taxed on receipt of the interest in the GP that represents the carry, if that interest is received at a time when the value of the Fund’s portfolio is not greater than the preferences of its investors.

The Fund’s income and gains will flow through to the principal, so their share attributed to the carry will have the same character, and will be realized at the same time, as the underlying income and gains of the Fund. Thus, if the Fund realizes capital gains or other income taxed at a favorable rate, the principal’s share attributable to the carry will also qualify for favorable treatment.

Congress may change US rules so that carry is taxed at the same rate as compensation income. However, it would still be necessary to be mindful of the consequences to non-US principals of the structure of the Fund, the GP and the carry.  

United Kingdom

Realizations of carry in the UK are typically liable to capital gains tax of 28 percent. This assumes the carry vehicle is treated as transparent. If this is the case, carry will have the same character and be realized at the same time as the underlying income and gains of the Fund.

However, for UK tax purposes, an LLC is treated as “opaque” rather than transparent, and holders of interests are typically treated as holding interests (or equivalents) in a stock corporation. Therefore, distributions (even of capital proceeds) are likely to be treated as dividend income and taxed at higher income rates. UK-based principals may therefore be disadvantaged by holding their carry through an LLC. Alternative structures may need to be explored, such as using a limited partnership, as a GP.

Principals with carried interest will not fall within the scope of entrepreneurs’ relief — which would otherwise result in the taxation of up to £5 million (€5.7 million) of gain at an effective rate of 10 percent — as the scope of this relief is too narrow to encompass carry. In addition, the acquisition of a carry right is regarded as the acquisition of securities for the purposes of the UK employment securities legislation. However, in practice this becomes problematic only if principals do not acquire their rights at the outset of the Fund, or do not fall within the so-called “safe harbor” rules agreed between HMRC and the BVCA.


Under current French law, foreign limited partnerships or LLCs are not generally treated as fiscally transparent. As a result, French resident principals’ realizations of carry in the Fund will typically be regarded as foreign securities income and taxed at progressive rates up to around 50 percent. In certain circumstances, they may also be subject to social security contributions if regarded as compensation income.

However, a favorable tax treatment exists for carry derived from investment entities located in the EU, Iceland or Norway (qualified jurisdictions). Under that regime, subject to certain conditions, a capital gains tax rate of 30.1 percent applies to a principal’s share of distributions of capital gains realized by qualifying investment entities.

Alternative structures could thus be explored to optimize tax treatment, such as using an entity located in a qualified jurisdiction as a parallel vehicle. The vehicle would need to qualify as an investment entity and thus include other investors in addition to French principals. This would require a rather complex structure, and may also raise tax issues in other jurisdictions where the investors are resident.


Under the US/UK fund structure, German tax resident principals would be taxed at their personal rate of up to 45 percent, as the carry would be deemed to be income from services rendered to the Fund. A more favorable treatment may be obtained by adding a managing LP and complying with the requirements of a ruling issued by German tax authorities in 2003, which would give the principals a 40 percent tax exemption on carry. The applicable tax rate then would equal the rate on capital gains of a German individual. This treatment depends on the overall structure and requires complete tax transparency of the Fund and any other entities between the Fund and the principals, which may limit its flexibility regarding other jurisdictions.


When dealing with the structuring of carry arrangements, it is important to remember that a typical US arrangement will not always be advantageous to non-US principals. It is likely to be necessary to consider local tax rules and alternative arrangements.