Luxembourg reshapes its carried interest regime, opening new opportunities for fund sponsors

The reform in particular widens the range of professionals eligible – if subject to taxation in Luxembourg – for the contractual carried regime such as managers, employees, partners and directors of investment funds and investment fund managers, as well as individual (advisory) service providers in fund management. Under the reformed regime, contractual carried interest can now benefit from a favourable tax treatment by being taxed at one quarter of the global tax rate (currently a maximum effective rate of approximately 11.24%) and, most importantly, the reform removes the former 10-year holding period requirement that would have made contractual carry ineligible. The once-overlooked contractual carry is broadening its reach, giving fund sponsors genuine reasons to revisit carry structures, including for roles previously excluded, and offering an easy-to-implement tool for non-equity-based, performance-linked incentives. In its new form, the contractual carry could potentially serve as an alternative to virtual stock option plans or other long-term bonus arrangements, either on a standalone basis or in hybrid combinations with more traditional invested carry plans.

For sponsors, the reform creates a more flexible and reliable incentive framework. This is achieved through greater tax clarity as uncertainties around the nature of the underlying income are removed. Carried interest is now always treated in the same manner as speculative gains from the disposal of shares or units, regardless of the tax transparency of the fund and irrespective of the nature of the fund's underlying income. As speculative gains, carried interest benefits from a full tax exemption if the disposal occurs more than six months after its acquisition (to the extent that the carried shares represent a participation of less than 10%). This uniform treatment simplifies structuring and administration by eliminating the need for complex look-through analyses of underlying fund income and offers predictable tax outcomes for beneficiaries. Besides, the reform offers enhanced flexibility to structure either whole-fund or deal-by-deal plans reflecting actual value creation by allowing carried interest to be distributed whenever it is economically sound. This enables sponsors to set up performance-linked remuneration schemes better reflecting variable investment outcomes with interim carried distributions and enhanced tax treatment predictability. Some technical aspects – including valuation of carried interest at fund’s launch and requirement for minimum investment – may still need fine-tuning, but these can be readily managed when designing and drafting the plans.

In practice, the reform equips sponsors with enhanced operational flexibility across three key dimensions. First, the expanded scope of eligible beneficiaries enables the sponsors to extend carried interest arrangements to a wider range of professionals involved in the fund's management and its investments. Second, sponsors may now tailor incentive packages to specific investment strategies and asset classes, by leveraging diverse carried interest structures, from whole-fund waterfall models to deal-by-deal arrangements. Third, and most importantly, the strengthened tax certainty offered by the reform eliminates previous ambiguities making the regime more attractive to key talents targeted by the sponsors. Collectively, these changes provide sponsors with a more flexible and effective tool to reward performance, align incentives with market realities and attract top talent in Luxembourg.