Alternative Investment Funds (AIFs) are pooled investment vehicles regulated by SEBI, where funds are collected from investors (Indian or foreign) for investing as per a defined investment policy. AIFs are categorized into three categories. Investors can choose any category according to their preference of sectors & types of investments.
Categories of AIFs
There are three categories of AIF:
1) Category I
2) Category II
3) Category III
Taxation of Category I & Category II
Taxation in the hands of investors.
There is a special taxation regime u/s 115UB of the Income-tax Act, 1961 under which Category I & II AIFs have been granted pass-through status (except business income). This means income earned by the AIF (other than business income) is taxed in the hands of investors as if the investments were made directly by them.
The nature of income (capital gains, interest, dividend, etc.) remains the same in the hands of investors.
Exemption in the hands of Funds
Income (other than business income) is exempt in the hands of the AIF. Business income, if any, is taxable at the fund level at Maximum Marginal Rate (MMR).
Taxation based on nature of income (in hands of investors)
The tax rate depends on the type of asset in which AIF has invested:
Exemption for units in International Financial Services Centre (IFSC)
Certain tax benefits may be available to AIFs set up in IFSC, subject to conditions. Under Section 80LA, eligible units in IFSC can claim deduction of specified income for 10 consecutive years out of 15 years, subject to fulfillment of conditions.
Taxation of Category III
Unlike Category I & II, pass-through taxation is not available to Category III AIFs. Tax is generally levied at the fund level.
Income earned by Category III AIF is typically taxed at Maximum Marginal Rate (MMR), depending on the nature of income and structure of the fund.
The distribution made to investors is generally not taxed again in the same manner as pass- through income, avoiding double taxation in most cases.
Conclusion
AIF taxation in India depends heavily on the category of fund and nature of income. Category I & II enjoy pass-through benefits (except business income), while Category III funds are taxed at the fund level. Investors should evaluate tax implications based on asset class, holding period, and regulatory structure before investing in AIFs.
FAQs on Taxation of AIF
Q1. What is pass-through status in AIF?
Pass-through status means that income (other than business income) is not taxed at the fund level but is directly taxed in the hands of investors as if they earned it themselves.
Q2. Which AIF categories get pass-through taxation?
Category I and Category II AIFs are granted pass-through status under Section 115UB of the Income-tax Act.
Q3. Is Category III AIF double taxed?
No, Category III AIF is generally taxed at the fund level, and income distributed to investors is typically not taxed again in the same manner, avoiding double taxation in most cases.
Q4. How is business income taxed in AIF?
Business income is taxed at the fund level at Maximum Marginal Rate (MMR), even for Category I and II AIFs.
Q5. What is the tax rate on capital gains from AIF?
Tax rate depends on the type of asset (listed or unlisted) and holding period. For example, listed equity LTCG is taxed at 10% above Rs. 1 lakh, while unlisted shares are generally taxed at 20% with indexation.
Q6. Are dividends from AIF taxable?
Yes, dividend income received through AIF is taxable in the hands of investors at applicable slab rates, and TDS may apply.
Q7. Do AIFs in IFSC get tax benefits?
Yes, AIF units set up in IFSC may claim tax deductions under Section 80LA, subject to certain conditions and eligibility requirements.
Q8. Is TDS applicable on AIF income?
Yes, TDS provisions may apply depending on the nature of income and residential status of investors.
CA Vidhu Duggal
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