In brief
On 22 January 2026, the Luxembourg parliament adopted Bill No. 8590, introducing a modernized tax regime for carried interest, applicable from the 2026 tax year. Subject to its formal enactment — expected following a waiver of the second constitutional vote — the new regime will become applicable from 1 January 2026. Combined with the inpatriate regime in force since 1 January 2025, the new carried interest regime further strengthens Luxembourg’s attractiveness as a location for highly skilled professionals and fund managers considering relocation.
Compared to the initial draft of 24 July 2025, the adopted text confirms the two-track approach (distinguishing between contractual and participation-linked carried interest) and provides better clarity on the scope of eligible beneficiaries, thereby further reducing the risk of interpretive uncertainties. The repeal of the transitional regime introduced by the Alternative Investment Fund Manager (AIFM) law is also confirmed.
For further information or to discuss the potential implications of these developments for you or your organization, please get in touch with your usual Baker McKenzie contact.
Key takeaways
A broad definition of carried interest
The bill applies to carried interest acquired under a contract (“Contractual Carried Interest”) and to carried interest strictly linked to, or represented by, a direct or indirect investment in the underlying alternative investment fund (“Participation Carried Interest”).
In both cases, carried interest compensates the alternative investment fund manager with a share of the fund’s overperformance. This aligns the manager’s interests with those of the investors. Ordinary bonuses cannot be structured as carried interest.
Why it matters: The regime is not confined to profit distributions, but may apply, for instance, to capital gains realized on so-called carry shares and to contractual payments. The regime applies to existing and new funds, to Luxembourg and to foreign funds, and to old and new carried interest regimes.
Clarification of the scope of beneficiaries
The adopted bill includes a specific description of eligible beneficiaries, which include the following two main categories:
- Individuals who perform investment‑related management functions (including portfolio and risk management) as employees, partners, managers or directors of AIFs, AIFMs or management companies
- Individual service providers who are involved in AIF management under an advisory agreement, whether concluded directly or through one or more intermediary entities
Involvement in the management of the fund is necessary; purely administrative roles do not benefit from the regime. This drafting reduces interpretive risk and aligns with market practice.
Why it matters: Sponsors and HR teams can structure carried interest awards for key persons, regardless of whether they are employees or nonemployees, with greater certainty.
Tax treatment
The adopted bill confirms the two categories of carried interest and their respective tax consequences, detailed as follows:
- Contractual Carried Interest: The bill classifies purely Contractual Carried Interest as extraordinary miscellaneous income. Accordingly, this income is taxed at one-quarter of the global personal income tax rate.
- Participation Carried Interest: The bill treats this income as speculative income, which is not taxable when the relevant participation has been held for more than six months and the beneficiary does not hold a substantial shareholding that exceeds 10%. For the purpose of classifying carried interest, tax-transparent funds, such as common contractual funds (fonds commun de placement) and transparent entities, are considered opaque.
Why it matters: The tax treatment applicable to both Contractual Carried Interest and Participation Carried Interest is particularly attractive, and it is expected to support the gradual establishment of mid office and front office functions in Luxembourg. In turn, this is likely to encourage the consolidation of key fund management and decision making roles in Luxembourg, thereby strengthening the economic substance of Luxembourg established investment funds and enhancing the overall coherence of fund structures. Additionally, the deemed tax opacity applicable to carried interest distributions provides significant structuring flexibility, allowing payments made by tax transparent funds to retain their character as carried interest, regardless of the nature of the underlying income.
Deal‑by‑deal carried interest and hurdle rate
The reform removes the previous full capital recovery precondition for the recognition of carried interest. As a result, deal by deal waterfalls can benefit from the preferential regime, provided the other statutory conditions are met. Any escrow or clawback mechanics remain commercial arrangements.
Regarding the hurdle rate, it is assumed that a minimum remuneration of the investors is implicit in the definition of “overperformance” of the fund and the result of the negotiation between the parties concerned.
Transitional regime repealed
The transitional quarter rate in the AIFM law has been repealed. The reformed regime is broader than the AIFM law regime, and it is structured so that it automatically applies to existing carried interest. Starting 1 January 2026, carry holders would be in an equal or better position under the new regime.
Recommended actions
- Map current and pipeline carried interest payments against the distinction between Contractual Carried Interest and Participation Carried Interest, and consider whether any awards should be restructured to benefit from the permanent one quarter rate applicable to Contractual Carried Interest
- Review carried interest plans, General Partner (GP)/management equity arrangements and award documentation to ensure alignment with the revised eligibility criteria, with particular focus on advisers, operating partners, deal team consultants and other nonemployee participants
- Revisit deal‑by‑deal carry mechanics, including escrow, clawback and waterfall provisions, to reflect the removal of the full capital‑return condition, and ensure consistency across fund documentation, investor disclosures and internal governance processes
- Reassess employment, partnership and advisory arrangements for front office investment professionals in light of the new carried interest regime, including in the context of team moves, new fund launches and Luxembourg-based platforms buildouts