Category I and II: pass-through
- Income other than business income is taxed in the investors’ hands, with the same character (capital gains, dividends, interest) as if they had invested directly. This was section 115UB of the 1961 Act; the Income-tax Act, 2025, in force from 1 April 2026, carries the regime forward.
- Since the Finance Act 2025, securities held by Category I and II AIFs are treated as capital assets, so gains on them are capital gains, not business income.
- Losses (other than business losses) are passed to investors who have held units for at least 12 months.
Business income stays with the fund
Any business income of a Category I or II AIF is taxed at the fund level — at the rate applicable to the fund’s legal form — and exempt in investors’ hands when distributed.
Category III
- No pass-through: a Category III AIF set up as a trust is taxed at the trustee level as a representative assessee.
- If investor shares aren’t determinate, the maximum marginal rate can apply. A July 2025 Delhi High Court ruling held that a Category III trust isn’t indeterminate simply because investors aren’t named in the trust deed.
TDS on distributions
- When a Category I or II AIF distributes income (other than business income) to a resident investor, it deducts 10% TDS.
- For non-resident investors, TDS applies at the rates in force, with treaty relief where the investor provides the required documents.
- The fund files an annual statement of income distributed to each investor so they can report it in their returns.
Non-resident investors
- Foreign investment in AIF units is permitted under the automatic route, from investors in jurisdictions that meet SEBI’s cooperation requirements.
- Where the sponsor or manager isn’t owned and controlled by resident Indian citizens, the AIF’s downstream investments count as indirect foreign investment.
- For global investors, a GIFT City fund can be more efficient — see GIFT City vs SEBI AIF.
Frequently asked questions
Are AIFs taxed in India?
Category I and II AIFs are pass-through for income other than business income, which means investors pay tax as if they had invested directly; business income is taxed at fund level. Category III AIFs are taxed at fund or trustee level.
What is the TDS rate on AIF distributions to resident investors?
10% on income (other than business income) distributed by Category I and II AIFs to resident investors.
Are gains of Category I and II AIFs capital gains or business income?
Since the Finance Act 2025, securities held by Category I and II AIFs are treated as capital assets, so gains on them are capital gains.
Please note: this guide is general information based on the rules as they stood on the review date above. Regulations and RBI/CBDT procedures change often — please get advice on your specific facts before acting.