On 24 July 2025, Draft Law No 8590 was submitted to the Luxembourg Parliament (Chambre des Députés) intending to update and render more attractive the tax regime for carried interest granted to managers of alternative investment funds (“AIF”).
The proposed changes aim at attracting more front office employees to Luxembourg by increasing the scope of beneficiaries and taking into account various forms of carried interest.
Background
The proposal is in line with the 2023-2028 coalition program of the government that committed to provide for an attractive framework for alternative investment funds and their managers including a review of the carried interest tax regime.
The existing carried interest tax regime was introduced by the Law of 12 July 2013 relating to alternative investment fund managers transposing the AIFM directive 2011/61/EU including a standard regime and a temporary favourable regime. The standard regime is dedicated to employees of the alternative investment fund manager (“AIFM”) or management company and provided for the full taxation of the carried interest based on a profit-sharing right and the application of the ordinary regime for capital gains (which could result in the tax exemption of the capital gains realized after a 6-months holding period) on the portion of the carried interest that could be linked to the disposal of a participation held by the manager in an underlying corporate entity. The temporary favourable tax regime provides for a reduced taxation of the carried interest for a period of 10 years at the quarter of the applicable global tax rate under the condition that the beneficiary redomiciled to Luxembourg before 2018.
The Draft Law draws from this regime and the feedback it received thereon to propose amendments that increase legal certainty and broaden the scope of eligible persons and forms of carried interests.
Proposed tax regime
The Draft Law broadens the scope of eligible persons and provides for a different tax regime depending on whether the carried interest is a contractual arrangement only or involves the holding of an interest.
Eligible individuals
Eligible persons are broadly defined as including any natural person who can be the manager or any other person at the service of the manager or the management company of an AIF. Commentaries to the Draft Law mention that the beneficiary can be employed by another entity than the AIFM, such as an advisor, and be in a relationship other than employment with the AIFM, such as an independent director.
Compared to the existing regime, the scope of the proposed regime is broader and not limited to employees of the AIFM or the management company.
Contractual arrangements
- Carried interest definition: The Draft Law refers to a participation in the fund’s “outperformance” on the basis of a profit-sharing arrangement granting specific rights over the fund’s net assets and income in order to include the broadest possible definition of carried interest. Commentaries to the Draft Law clarify that “outperformance” refers to the performance exceeding a pre-determined hurdle rate. It is also mentioned that such hurdle rate shall correspond to market practice to steer clear from any requalification under the abuse of law concept.
- Form: The carried interest is solely based on a contractual arrangement (e.g., provided for in the Limited Partnership Agreement). Under this form, the beneficiary is not required to acquire an interest in the AIF nor hold an interest mirroring the AIF’s performance.
- Payment: The commentaries to the Draft Law provide that the remuneration can be paid by the AIF or another entity (e.g., the general partner). The preexisting requirement that investors shall be repaid their invested amounts first is removed considering that AIF investors are informed and contractual arrangements generally provide sufficient protection (such as claw back clauses). Thus, carried payments on a deal-by-deal basis would now be eligible to the regime.
- Reduced taxation: The remuneration under those types of carried interest will be subject to a quarter of the global tax rate applicable to the taxpayer. Eligibility to such tax regime is not time limited as under existing rules which provide for a favourable tax treatment for only up to a 10-year period.
Participation based arrangements
- Form: The participation based carried interest covers two forms. First, the above-described contractual interest when it is accompanied with the requirement to hold a direct or indirect participation in the AIF. The commentaries add that the link between the carried interest and the participation should have an economic reality in terms of amount and duration to avoid steer requalification under the abuse of law concept. The second form is where the individual can acquire a participation in another vehicle entitling the holder of said participation to a carried interest.
- Taxation: The remuneration representing the carried interest follows the ordinary rules applicable to capital gains and is not considered as a taxable income if received more than 6 months after the investment (unless it represents a participation in a corporate entity exceeding a stake of 10% in the capital of such entity). Income resulting from the participation and not representing the carried interest remains subject to the ordinary tax regime.
- Legal forms of the investment vehicle: For the taxation of the participation based carried interest at the level of the beneficiary, the legal form of the interest issuer is disregarded. This is a welcome simplification as applying the tax transparency of partnerships or mutual funds could complexify the tax qualification at the level of the carry beneficiary.
Interaction with existing carried interest regime
The Draft Law that should come into force, if approved by the parliament, in 2026 intends to abolish the existing carried interest tax regime as from fiscal year 2026. The commentaries provide that the new rules are sufficiently broad provide for a more favourable taxation of all beneficiaries under the current carried interest regime.
Key Takeaways
The current carried interest tax regime is being phased-out as some shortcomings were identified. The Draft Law provides for a favourable tax regime to a larger variety of carried interest arrangements available in the market. In addition, it enlarges the scope of eligible beneficiaries previously limited to AIFM employees. In addition, it should limit preexisting difficulties pertaining to the qualification of the income received when the beneficiary is also an employee.
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