Luxembourg introduces carried interest tax reform

On 24 July 2025, the Luxembourg Government released draft Bill No. 8590, introducing reforms to the carried interest tax framework. The legislation aims to attract front-office activities to Luxembourg whilst providing enhanced legal certainty for alternative investment fund ("AIF") managers and their staff.

Strategic context and legislative rationale

The reform addresses critical gaps in Luxembourg's current dual-regime structure. The existing framework comprises a temporary regime under the 2013 AIF Law (closed to new entrants since 2018) and Article 99bis of the Luxembourg Income Tax Law ("LITL"), which has faced interpretative challenges due to the diverse forms carried interest arrangements can take in practice.

The Government's coalition agreement explicitly committed to evaluating the carried interest regime to determine necessary improvements for attracting front-office activities. 

Fundamental structural changes

Enhanced beneficiary scope

The legislation significantly expands eligible beneficiaries beyond traditional AIF manager employees. The new framework encompasses all individuals serving fund managers, including:

• Employees of investment advisory companies;
• Independent AIF board members;
• Management company partners; as well as
• Any individual directly or indirectly serving AIF managers or management companies.

This expansion 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 draft 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 is always treated as speculative gains, regardless of whether the underlying AIF generates capital gains or dividend/income distributions. The carried interest benefits from tax exemption when the participation does not exceed 10% and is held for more than six months. However, it remains unclear whether the tax exemption requires treating each carried interest payment as a partial sale of the participation, or whether ongoing distributions qualify if the participation itself is held long enough. If these conditions are not met, the carried interest is taxed at progressive standard rates 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

If adopted, the new regime will apply as from fiscal year 2026. The temporary regime under Article 213 of the AIF Law will be abolished, with existing beneficiaries automatically transitioning 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.

Parliamentary discussion is expected through the last quarter of 2025. If adopted, the new regime would apply as from 1 January 2026.

The reform represents Luxembourg's most significant carried interest legislation since 2013, positioning the jurisdiction to compete effectively with evolving European regimes whilst maintaining its leadership in the global fund management sector.