Luxembourg Tax Alert 2025-03

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Luxembourg Tax Alert 2025-03

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Major step towards modernizing the personal taxation of carried interest in Luxembourg

On 24 July 2025, the Luxembourg Government submitted Bill No. 8590 (the “Bill”) to the Chamber of Deputies, a long-awaited initiative aiming to modernize the personal tax regime for carried interest. The reform is positioned as a strategic move to reinforce Luxembourg’s role as a leading European hub for alternative asset management, offering fund professionals greater legal certainty, international alignment, and a more competitive tax environment. The Bill seeks to introduce a permanent and comprehensive framework that better aligns manager incentives with investor performance.

What does the project offer?

  • A clear distinction between ordinary returns and “outperformance” returns.

  • Replaces the enumeration of holding types with a broad, catch-all reference that encompasses all forms of holdings, including both corporate and partnership structures.

  • Two personal income tax treatments, depending on whether the carried interest is contractual (granted without any capital contribution or equity stake), or investment-linked (tied to a direct or indirect ordinary participation in the AIF).

Contractual carried interest

 

This qualification applies when carried interest is granted purely on a contractual basis, without requiring any capital contribution from the beneficiary. In such cases (i) the carried interest is granted free of charge to the manager, (ii) no direct or indirect equity stake in the AIF is required, and (iii) the amounts are paid from AIF resources, once the hurdle rate is achieved.

  • Personal taxation: Such income would be classified as extraordinary income and would benefit from a favorable personal tax rate – equivalent to one-quarter of the standard global income tax rate (approximately 13%, including a 1.4% dependence contribution).

  • Non-resident beneficiaries: The applicable Double Tax Treaty provisions should be referred to in order to determine the effective taxation in their hands.

  • Objective: To remove capital barriers and promote Luxembourg as a preferred location for front-office functions in asset management.

Profit-sharing rights that are inextricably linked to a direct or indirect "ordinary" holding in the AIF or represented by a holding entitling the holder to profit-sharing rights

Two situations may arise:

(i) Either the beneficiary would hold an ordinary interest in the fund (i.e., an ordinary interest or co-investment), or

(ii) The beneficiary would hold carried interest that would be integrated in a financial instrument (e.g. preferred units – carry units – in a vehicle) acquired at fair market value (referred to in the Bill as “carry invest”).

In the first case, carried interest is received on a contractual basis, but the individual is also required to take a direct or indirect "ordinary" stake in the AIF. An ordinary stake refers to the acquisition of an ordinary interest (i.e., co-investment) by the individuals themselves. Only the “outperformance” proportion (i.e. returns above the hurdle rate, known as carried interest) is subject to a personal tax treatment as speculative gain, which may be tax-exempt under certain conditions.

In the second case, the manager is offered the opportunity to acquire the carried interest for consideration through an investment via an ad hoc vehicle. The Bill gives examples of vehicles such as a Luxembourg special limited partnership or a foreign partnership.

For personal tax purposes, transparency is disregarded, meaning carried interest is systematically treated as speculative income, even for FCPs or other transparent structures. This also prevents “dry tax” situations, where investors might otherwise be taxed on reinvested (and undistributed) income from fiscally transparent vehicles.

Additional key measures

Several important changes to further streamline and modernize the personal tax regime of carried interest:

  • Expanded eligibility criteria: The circle of beneficiaries would receive more flexibility without opening the door to abuse, which may consist, in particular, of disguising a fixed income or a "bonus" from professional income, as miscellaneous income with a possible more advantageous personal tax treatment.

  • Repeal of the transitional regime (Art. 213 L.F.I.A.) in favor of a permanent, structured framework.

  • Clarification of the personal tax treatment of deal-by-deal carried interest, further improving legal certainty for tailor-made fund arrangements.

By aligning carried interest taxation with international market practices while maintaining competitive advantages, this Bill would reflect Luxembourg’s continued commitment to fostering a transparent, stable and attractive financial environment.

Should the Bill be adopted in its current form, it would significantly enhance the country’s ability to attract alternative investment fund managers and talent, helping shift more front-office functions to Luxembourg. Luxembourg is set to modernize and make permanent its carried interest personal tax regime with broader access, clearer rules and a competitive edge for those structuring outperformance incentives.

What’s next ?

The draft law has now been submitted and will need to go through parliamentary discussions and approval before adoption. 

We look forward to engaging in further discussions on these topics and will continue to closely monitor all legislative developments in this area. For this purpose, we will shortly organize dedicated round tables with our clients that should take place mid-September. Stay tuned – you will be contacted soon.

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