Phron Weekly #8: Carried Interest Taxation

Hi Everyone!

Welcome to the eighth edition of Phron Weekly! This week's review explores true success and carried interest legislation.

Reflections and Growth

Francis Chan is an influential Christian author, speaker, and former pastor. He is best known for his Christian works, such as Crazy Love andForgotten God. Chan's teachings often revolve around purposeful living and the pursuit of life grounded in values.

At its core, this quote explores the concept of misplaced ambition, suggesting that people may fear failure so intensely that they focus solely on success. However, this focus often is in the wrong areas. Chan implies that true failure lies not in stumbling but in dedicating oneself to pursuits that ultimately lack meaning or lasting impact. This distracted pursuit stems from a “value blindness,” where societal pressures or personal insecurities drive people to seek external validation through achievements that may not resonate with their deeper values.

Chan's quote encourages individuals to evaluate their motivations and align their efforts with their values. I explain this idea in my article about leading your life with a mission statement. To live a fulfilling and authentic life, we must stay true to ourselves and act in accordance with our values. While success is generally good, we must remember the importance of failure. Failure is the stepping stone towards success.

Your Next Move

This week, consider if you value success in an unimportant area more than failure in an important area. Which is truly better?

Business Insights

Carried Interest Gets Heavier

Last week, UK Chancellor Rachel Reeves announced anticipated reforms to the taxation of carried interest. These reforms are consequential as private capital firms have earned more than $1 trillion in carried interest since 2000.

Carried interest is the share of profits that private equity, venture capital, and hedge fund executives keep when they exit investments. These businesses often gather investors for a fund to pursue projects for a return. Carried interest is a performance fee aligned with the general partner's compensation and the fund's returns. Carried interest is typically only paid after the fund achieves a minimum return known as a hurdle rate — the lowest rate of return a project must reach before an investor deems it acceptable.

The controversy lies in carried interest taxation. Carried interest is typically taxed as a long-term capital gain, a much lower rate than regular income tax. Countries have their own qualifications for eligibility, but they generally are similar. For example, the US requires that investments for these firms be held for longer than three years to be considered capital gains. Many buyout managers argue this treatment is legitimate as they invest some of their capital alongside their outside investors. While true, the medium manager contribution is 2% of the total fund. Given this fact, it is argued that carried interest is a performance-related pay rather than an investment return and should, therefore, be taxed as ordinary income.

The UK announced that from April 2025, the tax rate on carried interest will increase from 28% to 32%. Additionally, the UK government is looking to treat carried interest as ordinary income starting in April 2026. These recent changes in policy display how governments use policy to shift markets for long-term outcomes. While the private equity industry has positively impacted the UK economy, it does not mean it is in the government's interest to tax them less in fear of them moving out. The UK government stated that “the current tax regime does not appropriately reflect the economic characteristics of carried interest and the level of risk assumed by fund managers in receipt of it.” In these reforms, the UK government claims to ensure fairness in the tax system while protecting its position as a “world-leading asset management hub.”

Some action steps for you:

• Consider how different countries approach your industry. Policy shifts can indicate a potential global move.
• Assess your business's tax policy risk exposure. Be aware of potential threats and plan for sudden changes in laws and taxes.

Some links for you:

• UK Government: The Tax Treatment of Carried Interest
• Investopedia: Carried Interest
• Investopedia: Hurdle Rate

Fun Fact: Did you know a squeeze of lemon or lime can tame spicy food? The citrus acidity helps neutralize capsaicin, the compound behind the heat!

Disclaimer: The content of this newsletter is for informational purposes only and does not constitute professional advice.