Partners in British-based private equity firms are likely to be faced with higher tax bills after the Treasury said it would apply the full rate of capital gains tax to deal profits.

The Budget marks a dramatic change for fund managers who receive carried interest.

‘Carried interest’ is the share of an investment or investment fund’s net profits allocated to the fund manager. It refers to the fund manager being carried by investors because he/she receives a share in profits disproportionate to his/her capital commitment to the fund.

Fund managers receive carried interest and a management fee, which industry executives feel is justified because each investment requires a lot of work to generate a profit. Fund managers do a lot of duediligence before making an investment because they invest large sums of capital, typically to acquire majority ownership. Thereafter, fund managers are heavily involved in strategy, business development, financial management and restructuring, and operational details. Among other things, they work to turn a company back to profitability, to restructure it to generate higher returns, or to unlock hidden value.

With effect from 8 July 2015, recipients of carried interest will be subject to capital gains tax (28%) on the full amount of that carried interest with no base cost. Until now, the regime allowed investment fund managers’ carried interest to be taxed at effective rates of capital gains tax below the normal rates.

The Chancellor also announced a consultation on carried interest in certain types of fund (e.g. hedge funds) being subject to income tax.

This change will have a very significant impact on funds and their principals and, in many cases, will result in a significantly higher tax liability.