Luxembourg's efforts to increase the appeal and competitiveness of private capital
Luxembourg Modernizes Carried Interest Regime, Attracting Top Talent
Luxembourg has introduced a significant reform to its carried interest regime, positioning the country as a leading jurisdiction for fund managers. The reform, outlined in Bill No.8590, aims to modernize the tax treatment, broaden the category of eligible beneficiaries, and align with international best practices.
The reform extends access to carried interest beyond fund manager employees to include directors, partners, shareholders of management companies, and employees of investment advisers. This move makes Luxembourg's carried interest regime one of the most attractive and competitive in Europe and worldwide.
The reform differentiates between two categories of carried interest: contractual carry and equity-linked carry. Contractual carry, qualified as extraordinary miscellaneous income, is taxed at one-quarter of the individual's global rate (approximately 13% including dependency contribution). On the other hand, equity-linked carry is treated as speculative income, taxable at personal income tax rates (up to 45.78%) if disposed of within six months but exempt if held for longer than six months - except where the participation exceeds 10% of the fund's capital, in which case the gain is taxed at half rates.
The quarter-rate taxation for contractual carry is made permanent, replacing the transitional regime under Article 213 of the AIFM Law. The reform also extends the preferential tax treatment to deal-by-deal carry structures, allowing carried interest to be paid to managers and other eligible participants based on the success of individual deals.
To further clarify the application of the reform, the Luxembourg tax authorities have published the Circular L.I.R. n°168quater/2. This circular provides guidance on the scope and application of the reverse hybrid rule, clarifying the collective investment vehicles ("CIVs") carve-out from the reverse hybrid rule under Article 168quater, paragraph 2 of the Luxembourg Income Tax Law ("LITL").
UCITS, Part II UCIs, SIFs, and RAIFs qualify as CIVs for the purposes of the carve-out, and are automatically excluded from the scope of the reverse hybrid rule. Other vehicles may also qualify for the carve-out, provided they meet all three conditions: widely held, diversified portfolio, and investor protection.
The Circular significantly reduces market uncertainty by confirming the automatic carve-out for mainstream Luxembourg fund vehicles and clarifying the conditions for others, thereby limiting reverse hybrid exposure and reinforcing Luxembourg's appeal as a secure and predictable fund jurisdiction.
The Bill has been submitted and is scheduled for parliamentary debate in the last quarter of 2025, with the new regime applying as from tax year 2026. This reform is expected to bring greater certainty and flexibility to Luxembourg fund structures, enhancing legal certainty around the classification and taxation of carried interest, and strengthening Luxembourg's ability to attract and retain top talent.
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