A Complete Guide on Taxation on AIFs in India
- Introduction to AIFs and Their Taxation in India
- What are Alternative Investment Funds (AIFs)?
- Types of AIFs in India: Categories I, II, and III
- Taxation of AIFs Investments In India
- Who Can Invest in AIFs in India?
- Conclusion
Introduction To AIFs And Their Taxation In India
India's investment landscape is not just equities or mutual funds, but also equal involvement of AIFs and private funds. In the last year, the nation has seen significant growth, reaching up to Rs. 13,00,000 crore (US$149.25 billion) as of December 31, 2024. This 5% QoQ increase has enabled investors (like HNIs and UHNIs) to let this instrument become a part of their investments. But have you ever wondered about the tax implications coming with AIFs?
As you explore the definition, various categories of AIFs, taxation of these Alternative Investment Funds (AIFs) in India, and more. Keep reading to engage more with this topic!
What Are Alternative Investment Funds (AIFs)?
Alternative investment funds (AIFs) are a pool of funds from investors that are later invested into various instruments (apart from equity and bonds). It explores other available options, including private equity, hedge funds, venture capital, angel funds, and REITs. They come with a customization feature that caters to the High-net-worth individuals (HNIs) and ultra-HNIs.
To streamline the interests of investors, the SEBI has listed certain rules for them, outlined in Regulation 2(1) of the Securities and Exchange Board of India Act, 2012. It focuses on the type of institution, who can invest, different categories, and AIF taxation rules.
Types Of AIFs In India: Categories I, II, and III
There are primarily three types of Alternative Investment funds available in India.
- Category I: This category of AIFs invests in growth-driven companies, small and medium-sized enterprises (SMEs), social ventures, venture capital, and infrastructure funds.
- Category II: Unlike Category I, Category II AIFs are more focused on private equity and debt funds. They maintain a closed-end yet minimum lock-in tenure of three years. Alongside, they also invest in distressed asset funds, real estate funds, debt funds, and fund-of-funds categories.
- Category III: The last category of AIFs invests in hedge funds, listed and unlisted companies, derivatives, complex and structured products, commodity derivatives, etc. They focus on short-term yield and maintain a closed-end or open-ended structure.
Taxation Of AIF Investments In India
There is a certain set of AIF taxation rules applicable to investment categories. It includes:
Taxation for Category I and II AIFs
- Any income (except business proceeds) is exempt at the fund level, but is taxable from the investor's side.
- Business income is taxed at the fund level (30% for Residents and up to 39% for Non-residents), which is exempt for investors.
- Non-resident Indians (NRIs) are taxed directly on their income, and they are required to file their Income Tax Return (ITR) annually.
- For distribution income (excluding business income), a 12.5% AIF taxation applies to retail investors, while for foreign investors, it is applicable at the standard tax rates.
AIF Taxation of Category III (Domestic)
- Company: These AIFs are taxed at corporate tax rates, where dividends paid to investors are subject to TDS.
- LLP: LLP is taxed on the total income earned. However, distribution (gains) is exempt for both LLP and investors.
- Trust (typical structure): Income taxed either in the hands of the Trustee (as representative assessee) or directly in the Investors' hands. If business income is earned, the entire income is taxed at the maximum marginal rate at the trust level.
Special Regime for Category III AIFs in GIFT City
- If units are held only by Non-resident Indians (except for the sponsor/manager), the interest/dividend gets taxed at a 10% rate.
- Capital gains (except Indian shares) are exempt from AIF taxation.
- Non-resident investors are exempt from Indian tax filing only if they earn income from an Alternative Investment Fund (AIF). However, taxes must be withheld to claim this exemption.
Who Can Invest In AIFs In India?
AIFs are open to all sorts of investors, including Resident Indians, NRIs, institutional investors, and foreign nationals. However, they must pass the eligibility criteria test that has certain requirements, like:
- A minimum AIF investment limit of ₹1 crore for investors and ₹25 lakhs for directors, fund managers, and employees.
- High-net-worth individuals and ultra-high-net-worth individuals (UHNIs) who have substantial capital and a high-risk appetite.
- AIFs have a minimum lock-in period of three years.
Conclusion
Taxation of AIFs in India might seem complex, but here's the bottom line. With the categories of AIFs, tax liabilities are also distributed. Therefore, if you are investing in the first two categories, the AIF taxation is passed on to the investor. However, with the third category, things get more layered. Depending on the fund setup, type of income, and where it's traded, the rules differ. In short, AIFs can be a great investment avenue — but knowing the tax rules helps you plan better and avoid surprises.
Disclaimer:This is for educational/information purposes only. The general topic and information do not aim to influence the investment/trading decisions of any investors.
