Luxembourg Government proposes reform of carried interest tax regime

On 24 July, the Luxembourg Government submitted a draft bill aimed at modernising and expanding the carried interest tax regime. The proposals, which are anticipated to apply from the 2026 tax year, aim to update the current framework and broaden its scope. 

Key highlights of the proposed regime:

• Broader eligibility – the scope of individuals residing tax-wise in Luxembourg who are benefiting from the regime is broadened to include not only employees of the AIF or AIFM, but also other persons directly or indirectly engaged with the management of the AIF, such as independent directors (board members), personnel of the portfolio manager, consultants or shareholders of the management company. 
• Flexible carry structures – the draft bill removes the previous requirement that all investors must have first recovered their initial investment, making “deal-by-deal” carry eligible under the new regime. The regime will also extend to situations where carried interest is paid by the AIF to its general partner or AIFM, provided that the carried interest is then passed directly on to the beneficiary.
• Permanent regime – the existing temporary carried interest regime will be repealed. Current beneficiaries will transition to the new regime, which will not be time-limited and should be at least as favourable.
• Beneficial tax rate for wholly contractual carried interest (not linked to an investment in an AIF) – income taxed at a quarter of the global income tax rate (approximately 11.5% if the individual is at the highest marginal rate).
• Full tax exemption for equity-linked carried interest – tax exempt if the holding period exceeds six months and the beneficiary does not hold a substantial participation (i.e., not more than 10%). The new rules also clarify the treatment of the carried interest received from tax transparent AIFs, treating it as directly received from the AIF, so as to create a level playing field between opaque and transparent funds. It is currently not yet clear whether carried interest payments must be structured as a (partial) sale of the participation, or if regular distributions of carried interest will also qualify for the tax exemption.
• Anti-abuse guidance – the bill of law clarifies that only genuine commercial/financial carried interest is covered. Carried interest structured as a fixed or recurring remuneration (e.g. a disguised salary) will not benefit from the favourable tax treatment.

This bill, together with the laws implementing an inpatriate tax regime and clarifying the use of alphabet classes of shares, gives yet another tool to employers to attract and retain talent. It is in line with the pro-business agenda of the governing administration.

We expect the draft bill to evolve as it progresses through the legislative process, and more guidance is likely to be issued. We will closely monitor any relevant updates and keep you informed.

Please liaise with your usual Linklaters contact if you have any questions regarding the above.