The interest tax rate has been increased to 32% and further increases are expected from 2026.

The increased tax rates will be a temporary measure ahead of a full reform of the tax system on interest, which is due to be completed by April 2026, according to a document released alongside Reeves' speech.

Peter Morley, tax expert at Pinsent Masons, said: Today's announcement comes with a mix of relief and warnings, with relief from the investment funds industry that the expected tax rate rise has been capped at 4% and caution about the impact of further increases. You will get a reaction. The reform will take effect from 2026.

The government plans to introduce a new regime for held interest to ensure that held interest is taxed within the income tax system. The reform proposals are outlined in a response document (28 pages/180KB PDF) to the government calling for evidence on the taxation of interest held, published in July. The Government recognizes the importance of maintaining the UK's competitive position as a global wealth management hub and believes the new regime will be simpler and fairer by ensuring fund managers pay their fair share of tax.

Hatice Ismail, money tax expert at Pinsent Masons, said: Under the proposed new regime, essentially all held interests would be treated and taxed as trading income at a rate of up to 45%, with Class 4 National Insurance coverage for certain eligible held interests. Donations are added. A lower effective income tax rate applies because only 72.5% of your income tax is taxed at your personal marginal tax rate.

Additionally, for higher rate taxpayers this would result in an effective tax rate of 32.625% plus NIC, she said.

Holding interest mainly refers to performance-related compensation received by fund managers in the private equity industry. Unlike other compensation, retained interest may be taxed at a lower capital gains tax rate compared to the current income tax rate of up to 45%. The government believes that the current tax system does not accurately reflect the economic characteristics of interest holdings or the risks borne by fund managers.

The proposed new rules apply equally to employees and self-employed fund managers. Additional conditions may be imposed on retained interest to qualify for a lower effective income tax rate. For example, a minimum amount of co-investment may be required, and a minimum period of time may be required between granting the right to receive interest and receiving payment of interest. The government is consulting on the design of these conditions until 31 January 2025.

No other taxes are levied on the interest held. The Government believes that this will significantly simplify existing tax rules, removing the complex interplay between general tax principles and statutory overlays.

There is no longer a need to undertake the complex task of determining the underlying nature of the amount received, but it is all considered transactional income, so the income-based interest rules are complex in themselves and additional terms are overlaid by the government. For interest to qualify for a lower effective tax rate would again add complexity, Ismail said. Notably, these changes do not appear to have any impact on the tax treatment of joint investments, and as a result, managers may be incentivized to increase joint investments in the future.

The government plans to set up a working group with stakeholders to look into technical details, and a draft bill is expected to be published in 2025.

It is positive that the government has accepted the complex nature of the tax rules on interest and has heeded industry advice that there should be no rush to introduce a new tax regime, Morley said.

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