The previous carried interest regime had significant limitations. Only individuals who became Luxembourg tax residents between 2013 and 2018 could benefit, the advantage was capped at ten years, and eligibility was restricted to employees of fund managers. Since 2018, no new individuals could qualify under the old rules. A modernised, permanent regime was therefore essential to ensure Luxembourg remains attractive to international talent in the alternative investment sector.

This reform forms part of a broader strategy to strengthen Luxembourg's position as a leading financial centre. Alongside the carried interest enhancements, the government has revamped the inpatriate regime (offering a 50 per cent tax exemption on income up to €400,000), improved profit-sharing schemes, and introduced a new tax regime for stock options aimed at start-ups.

The new law creates two distinct categories of carried interest, each with its own tax treatment.

Contractual Carry is the simpler of the two structures. Under this arrangement, the individual receives a share of the fund's profits through a carry payment without making any investment into the fund. It is essentially a performance-based bonus. The tax treatment is highly favourable: only one quarter of the normal income tax rate applies, resulting in an effective rate of approximately 11.5 per cent (or 13 per cent including the dependency contribution).

Participation Carry (sometimes referred to as "carried invest") involves the manager paying money to acquire the right to share in carry distributions. This is distinct from traditional co-investment; it relates specifically to the taxation of the carry distribution itself. There is no minimum euro amount required, nor any specific percentage of fund capital that must be invested. The key distinction lies in how the carried interest is acquired: Contractual Carry involves receiving a contractual right without payment, whereas Participation Carry requires a genuine investment. Provided two conditions are met—holding the investment for at least six months and owning no more than 10 per cent of the fund's capital—the carried interest is completely exempt from Luxembourg tax.

The new regime significantly broadens the categories of individuals who may benefit. It now covers all individuals actively involved in the management of an alternative investment fund, whether directly or indirectly. This includes employees of fund managers and management companies, partners and directors of those entities, individuals providing advisory services to the fund (provided they are active in management rather than purely administrative functions), independent board members of the fund, shareholders of management companies, and other non-employees who receive carried interest entitlements.

Importantly, the preferential regime applies only to individuals, not to companies. To qualify, an individual must be tax resident in Luxembourg under both domestic law and any applicable double tax treaty.

The new regime accommodates both EU-style whole-of-fund waterfall models and US-style deal-by-deal carry arrangements. The legal form of the fund—whether partnership, company or otherwise—does not affect whether the regime applies. In most cases, Participation Carry is structured through a dedicated special purpose vehicle, such as a Luxembourg special limited partnership, providing additional flexibility for clawback and other structuring considerations.

Fund managers and advisors should consider reviewing existing carried interest arrangements to assess their compatibility with the new regime, examining fund documentation (including LPAs and waterfall provisions) to ensure alignment with the new requirements, and carefully planning any relocation to Luxembourg to establish proper tax residency under all relevant rules.