Taxation – India Specific

1Pass-through for Category I and II AIFs

Category I and II AIFs have a special pass-through regime under the Income-tax law:

• Income of the fund, other than business income, is not taxed in the fund's hands. It is taxed in the investors' hands, as if they had earned it directly.
• The income keeps its character: capital gains stay capital gains, interest stays interest, dividends stay dividends. Each investor pays tax at their own applicable rates.
• Business income (for example, from trading) is taxed at the fund level and is then exempt in investors' hands.

This avoids double taxation and puts investors in roughly the same position as investing directly.

Remember

• Cat I/II: non-business income taxed in investors' hands, same character.
• Business income: taxed at the fund level.

Practise this concept (5 questions)

2TDS and reporting

• When the AIF distributes income to resident investors, it deducts TDS at 10% on the income portion (other than exempt income). For non-resident investors, TDS applies at the rates in force for them, considering tax treaties where applicable.
• The AIF gives investors statements showing the nature of income passed through, so they can file returns and claim TDS credit.

Example An investor's share of a Category II AIF's interest income is ₹10 lakh. On distribution to a resident, TDS at 10% = ₹1 lakh. The investor includes ₹10 lakh of interest in income and claims the ₹1 lakh TDS credit.

Practise this concept (5 questions)

3Losses

Losses of the fund (other than business losses) pass through to investors, but an investor may set them off only if they have held the units for at least 12 months. Business losses stay in the fund and can be carried forward and set off against its future business income.

Practise this concept (2 questions)

4Category III AIFs

Category III AIFs do not have the statutory pass-through regime. Their income is generally taxed at the fund level. For a trust structure, the rate depends on how the trust is set up and its beneficiaries. This is one reason why the post-tax returns of Category III AIFs need careful comparison.

Practise this concept (3 questions)

5GST and other points

• GST at 18% applies to management fees and similar service fees charged by the manager.
• Investors should consider both the fund-level tax and their own tax position when comparing net returns.
• Distributors should explain the broad tax position but refer clients to a tax adviser for personal advice.

Example A management fee of ₹2 lakh attracts GST of 18% = ₹36,000, so the total cost is ₹2.36 lakh.

Remember

• TDS 10% on income distributed to residents.
• Losses pass through only after 12 months' holding.
• Cat III: taxed at the fund level. GST 18% on fees.

Practise this concept (3 questions)