The Luxembourg Parliament approved legislation modernising the country’s carried interest regime on 22 January 2026. The revised rules, which apply as from 2026, aim to reinforce Luxembourg’s attractiveness for the alternative investment sector. The updated framework introduces a performance-based reward mechanism, broadens the scope of eligible beneficiaries and funds and distinguishes between two categories of carried interest.
Carried interest or “carry” refers to a performance-based reward granted to an individual for managing an alternative investment fund (AIF) that generates positive returns. This form of remuneration depends on the fund performance and is paid out when returns exceed a predefined threshold (known as the “hurdle rate”). Designed to incentivise fund managers and attract and retain talent, carried interest is paid in addition to salary and any management fee and is distinct from returns attributable to the manager’s own capital investment in the fund. Carried interest typically represents 20% of investment profits and is distributed only after investors receive a return of their capital contributions plus a pre-agreed rate of profit on funds invested.
The tax treatment of carried interest differs from country to country and is often the subject of debate. Some countries have enacted—or are in the process of enacting—dedicated carried interest regimes that provide preferential treatment if specified conditions are fulfilled and others classify carried interest as capital gains rather than ordinary income, resulting in lower tax rates.
Two types of carried interest
Carried interest structures in Luxembourg may be implemented either through a purely contractual arrangement or one that is tied to a participation in the AIF. The updated legislation distinguishes between these types of carried interest:
Tax qualification of carried interest
The regime confirms carried interest should be treated as speculative capital gains rather than employment income or trading income. As a result:
Individuals benefiting from the preferential regime for contractual carried interest include:
Recognition of two types of carried interest
Carried interest is defined as a share of the “outperformance” (above the hurdle rate) of an AIF distributed to an eligible beneficiary. As noted above, the previous rules required that investors be fully repaid before payout could be made to carry holders, which was viewed as preventing payout on a deal-by-deal basis; this requirement is repealed, making the regime more widely applicable.
The new regime treats carried interest differently depending on whether the beneficiary is required to make an investment.
The new carried interest regime enhances clarity and legal certainty in an inherently complex area. The key takeaways are broader application of the rules allowing more professionals involved in fund management to benefit, as well as clarification and simplification of the rules.
For professionals in the alternatives sector relocating to Luxembourg, the new rules can be combined with the revamped expatriate tax regime, which offers a 50% tax exemption on salary (up to EUR 400,000) for eight years, creating a compelling overall incentive structure.
Bertrand Droulez
Paul Leyder
Laura Zahren
Sylvie Leick
BDO in Luxembourg
Carried interest or “carry” refers to a performance-based reward granted to an individual for managing an alternative investment fund (AIF) that generates positive returns. This form of remuneration depends on the fund performance and is paid out when returns exceed a predefined threshold (known as the “hurdle rate”). Designed to incentivise fund managers and attract and retain talent, carried interest is paid in addition to salary and any management fee and is distinct from returns attributable to the manager’s own capital investment in the fund. Carried interest typically represents 20% of investment profits and is distributed only after investors receive a return of their capital contributions plus a pre-agreed rate of profit on funds invested.
The tax treatment of carried interest differs from country to country and is often the subject of debate. Some countries have enacted—or are in the process of enacting—dedicated carried interest regimes that provide preferential treatment if specified conditions are fulfilled and others classify carried interest as capital gains rather than ordinary income, resulting in lower tax rates.
Highlights of the New Regime
Two types of carried interestCarried interest structures in Luxembourg may be implemented either through a purely contractual arrangement or one that is tied to a participation in the AIF. The updated legislation distinguishes between these types of carried interest:
- Purely contractual carried interest: This refers to carried interest not linked to any form of investment, which is taxed at 25% of the beneficiary’s global tax rate, resulting in a maximum tax burden of 11.45% (plus the dependency contribution); and
- Carried interest linked to an investment: Where carried interest is linked to a direct or an indirect investment, standard capital gains tax rules apply. Gains are not taxable if the investment is held for more than six months and the beneficiary does not hold a substantial participation (i.e., more than 10% of the shares/quotas of the underlying vehicle within the last five years).
- The updated regime covers a broader range of alternative investment funds (AIFs), including private equity, real estate, infrastructure and debt funds.
- The previous requirement that investors be fully repaid before carry payout is eliminated.
- Deal-by-deal arrangements are now permitted.
- The regime is no longer restricted to employees of the AIFM or management companies. It also extends to directors, partners, advisors and other external individuals carrying out management functions.
Detailed Discussion
Tax qualification of carried interestThe regime confirms carried interest should be treated as speculative capital gains rather than employment income or trading income. As a result:
- The favourable regime can only apply to Luxembourg tax residents.
- Unlike the prior regime, beneficiaries no longer need to be newly established tax residents in Luxembourg.
- The capital gains classification applies regardless of any vesting conditions, good/bad leaver provisions or whether the distributing entity is transparent for tax purposes (e.g., an SCSp or FCP).
- Carried interest is taxed upon receipt.
Individuals benefiting from the preferential regime for contractual carried interest include:
- Employees, partners, managers or directors of AIFMs, management companies or AIFs; and
- Individuals providing direct or indirect (i.e., through intermediaries) management services under a service agreement.
Recognition of two types of carried interest
Carried interest is defined as a share of the “outperformance” (above the hurdle rate) of an AIF distributed to an eligible beneficiary. As noted above, the previous rules required that investors be fully repaid before payout could be made to carry holders, which was viewed as preventing payout on a deal-by-deal basis; this requirement is repealed, making the regime more widely applicable.
The new regime treats carried interest differently depending on whether the beneficiary is required to make an investment.
- Contractual carried interest (no form of investment required): Where beneficiaries are granted carried interest without any form of investment obligation:
- The gain is considered extraordinary income taxed at 25% of the individual’s tax rate (a maximum of 11.45%. plus the dependency insurance of 1.4%). The overall maximum rate is therefore below 13%.
- This favourable treatment is permanent with no time limit.
- If the beneficiary also makes a voluntary investment, returns on that investment follow the separate rules applicable to investment-linked carried interest.
- Carried interest linked to a direct or an indirect investment: If carried interest is granted in exchange for an investment in the AIF or dedicated vehicle:
- Standard capital gains rules apply to both the capital gain on the investment realised by the beneficiary upon a disposal of the investment and the carried interest distribution.
- Gains are exempt if the investment is held for more than six months and the beneficiary does not hold a substantial participation.
- Regular distributions received by the beneficiary from the investment are taxed under the standard movable income taxation rules.
- If the investment is acquired for no consideration or for below market value, a benefit-in-kind may arise at subscription.
BDO Perspective
The new carried interest regime enhances clarity and legal certainty in an inherently complex area. The key takeaways are broader application of the rules allowing more professionals involved in fund management to benefit, as well as clarification and simplification of the rules.For professionals in the alternatives sector relocating to Luxembourg, the new rules can be combined with the revamped expatriate tax regime, which offers a 50% tax exemption on salary (up to EUR 400,000) for eight years, creating a compelling overall incentive structure.
Bertrand Droulez
Paul Leyder
Laura Zahren
Sylvie Leick
BDO in Luxembourg