Luxembourg to reform carried interest tax

Luxembourg has long been a leading jurisdiction for fund domiciliation and administration. Now the country faces a challenge in attracting front-office activities, particularly active fund management. In response to this, the government introduced Bill No. 8590 on 24 July 2025, aiming to modernise the carried interest regime to align with market practices and attract qualified personnel in active fund management.

The bill is expected to be adopted in on 22 January 2026, after the amendment of the beneficiary definition required by the Council of State to be more precise and therefore provide more legal certainty.

Currently, the tax regime applicable to carried interest in Luxembourg is governed by Article 99bis of the Luxembourg Income Tax Law and by the law of 12 July 2013 on Alternative Investment Fund Managers.

However, with the scope of the current regime being too restrictive, the new proposed changes aim to enlarge that scope going forward.

Introducing a broader definition

Under the revised legislation carried interest qualifies as speculative capital gain rather than employment or trading income and, as a result, would not be subject to social security contributions.

Carried interest - which would not only include profit sharing on capital gain but also profit sharing on out-performance - should be taxed when received by the beneficiary no matter if it would be paid by the alternative investment fund (AIF) or its general partner.

Entitlement to carried interest is typically triggered when the fund achieves a pre-agreed ‘hurdle rate’ - the minimum return investors expect before sharing excess profit – which must be in alignment with market practices and cannot be set artificially low.

The bill broadens the scope of beneficiaries beyond just the salaries of the AIF or its management firm, extending it to individuals performing management functions with managers, management companies or AIFs (as employees, partners, managers, or directors); and individuals performing management functions via an advisory services contract. It also abolishes a previous requirement that investors must recover their full investment before managers can receive carried interest, allowing a broader range of structures to benefit from the new regime.

Unlike the current temporary regime, which restricts carried interest to be allocated within a 10-year period from granting/implementation of the carried interest, the new legislation will allow those affected to operate without time limits.

Clearer definitions

The new legislation keeps the existing distinction between the two types of carried interest, but with more precise definitions to ensure better clarity.

Contractual carried interest is not linked and does not require the beneficiary to acquire a participation in the AIF. The contractual carried interest would be qualified as extraordinary income taxed at one quarter of the global tax rate - up to 11.45% - without applying any time limitation and not restricted to new Luxembourg tax residents as it was the case in the previous regime.

In addition, comments published alongside the bill state that fixed income or standard bonuses shall not be transformed into non-genuine carried interest in an abusive manner, although no particular precision or detail is provided.

Meanwhile with participation-linked carried interest, the beneficiary must acquire a direct or indirect participation in the AIF or a participation represented by a participation in the AIF to be able to benefit from the participation-linked carried interest.

Participation-linked carried interest is tax-exempt if received more than six months after the investment is made by its beneficiary, unless linked to a participation exceeding 10% ownership. Other income from the participation remains subject to ordinary tax rules. Typically, the income derived from non-carried interest like any other investors would be taxed according to the general tax rules.

But for both definitions, the carried interest tax regime will apply regardless of the AIF’s legal form. This is to ensure consistency in the application treatment for tax-opaque entities, tax-transparent entities and common funds.

Impact and challenges

This reform is expected to enhance Luxembourg’s competitiveness in attracting active fund management, as it will provide clarity and predictability for fund managers and investors, aligning Luxembourg’s carried interest regime with international best practices.

The bill marks an innovative step toward positioning the country as a leading jurisdiction for private equity and alternative investment fund management.

Stakeholders should closely monitor legislative developments and assess their carried interest arrangements to ensure compliance and optimise tax efficiency.