Luxembourg adopts comprehensive carried interest tax reform
On 22 January 2026, Luxembourg's Parliament approved Bill No. 8590, delivering the jurisdiction's most ambitious carried interest tax reform since 2013. The new legislation establishes two distinct categories: contractual carried interest subject to reduced taxation, and participation-linked carried interest eligible for tax exemption under defined conditions.
Bill No. 8590 reshapes the carried interest tax regime as part of Luxembourg's strategy to attract front-office functions and provide alternative investment fund (“AIF”) managers and their personnel with greater legal certainty.
Context
The reform remedies fundamental weaknesses in Luxembourg's previous carried interest framework, which operated through two parallel regimes: a temporary regime established under the 2013 AIF Law (closed to new entrants since 2018) and the former version of Article 99bis of the Luxembourg Income Tax Law ("LITL"). The latter has posed particular interpretative challenges owing to the diverse structuring possibilities available for carried interest arrangements.
Fundamental structural changes
Enhanced beneficiary scope
The legislation significantly expands eligible beneficiaries beyond traditional AIF manager employees. The new framework encompasses individuals who are fund managers or serving fund managers or management companies, including:
- Employees of investment advisory companies;
- Independent AIF board members;
- Management company partners; as well as
- Individuals directly or indirectly at the service of AIF managers or management companies.
The initial draft was amended to define more precisely the beneficiaries "at the service of AIF managers or management companies". The regime now explicitly covers two pathways: (i) individuals exercising management functions (e.g. portfolio management) as employees, partners, managers of an AIF, AIF manager or management company, or (ii) those providing services contributing to the management of an AIF under a service agreement, concluded either directly or through one or more entities. This clarification eliminates previous uncertainties regarding tax treatment for non-employee recipients whilst maintaining anti-abuse safeguards against disguising fixed remuneration as carried interest.
Clarified dual-category framework
The law establishes distinct treatment for two categories of carried interest arrangements:
Contractual carried interest
This category covers arrangements that are neither inseparably linked to, nor represented by, a participation in the AIF. It needs to be granted without mandatory AIF investment requirement. It is to be paid directly or indirectly by the AIF upon achieving performance thresholds. Income under this category is subject to extraordinary income treatment at one-quarter of standard rates (approximately 11.45% at marginal levels).
Participation-linked carried interest
This category encompasses arrangements either inseparably linked to direct/indirect AIF participation or represented by such participation. This includes contractual arrangements requiring mandatory "ordinary" AIF investment and carried interest materialised through dedicated investment vehicles.
Participation-linked carried interest benefits from tax exemption provided that (i) the participation does not exceed 10% of the AIF, and (ii) it is held for more than six months. If either condition is not met, the carried interest is treated as a speculative gain and taxed at progressive standard rates of up to 45.78%.
Operational flexibility enhancements
The legislation removes the previous requirement that investors must recover their full investment before carried interest payments. This modification enables "deal-by-deal" carried interest structures to benefit from favourable tax treatment, aligning Luxembourg law with prevalent market practices.
The reform also permits carried interest payments via the AIF, fund manager, or general partner, provided proper flow-through to individual beneficiaries occurs.
Tax transparency clarifications
For participation-linked carried interest, the law disregards AIF tax transparency provisions (when applicable) solely for carried interest tax purposes. This ensures consistent treatment regardless of underlying AIF structure whilst maintaining transparency rules for other tax purposes.
Temporal and transitional provisions
The new regime is applicable as from fiscal year 2026. Individuals currently benefiting from the temporary regime under Article 213 of the AIF Law (which was closed to new entrants in 2018 and would otherwise expire in 2028) will automatically transition to the new permanent framework under equivalent or more favourable terms.
Significantly, the quarter-rate taxation for contractual carried interest operates without temporal limitations, recognising that investment cycles often exceed ten years and supporting manager retention for successive fund generations.
This reform constitutes the most far-reaching carried interest legislation Luxembourg has enacted since 2013, positioning the jurisdiction to meet the competitive challenge of evolving European regimes whilst consolidating its leadership in the international fund management industry.
