AIF Taxation in India: Complete Guide to Category 3 AIF Taxation
Wondering how Alternative Investment Funds (AIFs) are taxed in India? This comprehensive guide explains AIF taxation under SEBI regulations, including Category 3 AIF taxation, AIF tax rates, and investor benefits.
Key Takeaways
- AIF taxation in India depends on the fund category (I, II, III).
- Category I & II enjoy pass-through status — investors pay taxes directly.
- Category III AIFs are taxed at the fund level on all income types.
- LTCG 12.5% & STCG 20%
- SEBI structure and fund type influence AIF tax liability.
Understanding AIF Taxation in India
Alternative Investment Funds (AIFs) are pooled investment vehicles registered with SEBI under the SEBI (Alternative Investment Funds) Regulations, 2012.
Their taxation depends on the category, legal structure (trust, LLP, or company), and nature of income (capital gains, business income, interest, or dividends).
The Finance Act 2024 introduced a key change: Long-term capital gains (LTCG) on listed securities are now taxed at 12.5% beyond ₹1 lakh — impacting AIFs that invest in equities.
AIF Category I and II Taxation: Pass-Through Structure
Category I and II AIFs enjoy a pass-through status under Section 115UB of the Income Tax Act. This means the fund itself isn’t taxed (except for business income); the investor bears the tax liability.
Tax Treatment Summary
| Income Type | Taxed At | Tax Rate | Notes |
| LTCG (> 24 months) | Investor | 12.5% | or 20% with indexation (pre-July 2024) |
| STCG (< 24 months) | Investor | As per slab rate | Applies to residents & NRIs |
| Business Income | Fund | MMR (≈ 42.74%) | No pass-through |
| Dividend/Interest | Investor | Slab rate | Withholding @ 10% |
💡 Example:
If an investor in a Category II AIF earns ₹50 lakh LTCG, tax = ₹6.25 lakh (12.5%).
The fund doesn’t pay; the investor includes this in their return.
AIF Category III Taxation: Fund-Level Taxation Explained
Category III AIFs differ significantly — they don’t have pass-through status.
Instead, the AIF itself pays tax on all income at the fund level before distributing returns to investors.
Applicable AIF Tax Rates (Approximate Effective Rates including Surcharge and Cess)
Type of Income | Effective Rate |
STCG | 23.92% |
LTCG | 14.95% |
| Business Income | ~42.74% |
| Dividend Income | ~42.74% |
💡 Example:
If a Category III AIF earns ₹1 crore short-term gains, the fund pays about ₹20 lakh in tax before distribution.
Investors receive post-tax returns, avoiding double taxation.
Comparative View: AIF vs PMS vs Mutual Funds
Feature | AIF | PMS | Mutual Fund |
Regulator | SEBI AIF Regulations | SEBI PMS Regulations | SEBI MF Regulations |
Taxation | Category-wise | Investor level | Pass-through |
| Flexibility | High (Private Placement) | Medium | Low |
Liquidity | Moderate | High | High |
| Minimum Investment | ₹1 crore | ₹50 lakh | ₹500–₹5,000 |
Key AIF Tax Benefits
- Pass-Through Efficiency – For Category I & II AIFs, taxation is passed to the investor while in the case of Category III AIF, the taxation is at the fund level. In both cases, it is one time taxation.
- Professional Management – Expert strategies to optimize post-tax returns.
- Diversification – Exposure beyond traditional equities or debt.
- Tax-Hassle Free – As with Category III AIF, the taxation is addressed at the fund level, and the investors do not hold any tax liability on redeemed amounts.
- Compliance Transparency – Governed by SEBI and audited regularly.
Aequitas’ Edge
Our cat-3 AIF in India, prioritises risk management and aims for consistent growth. With a focus of ~25 stocks across sectors, and adhering to the same investment philosophy and approach as our flagship PMS, it focuses on valuation and margin of safety in listed Indian equities.
By maintaining disciplined portfolio allocation and adhering to the latest Finance Act 2024 norms, Aequitas’ AIFs aim to deliver sustainable, risk-adjusted wealth creation.
FAQs on AIF Taxation (Schema-Ready)
Q1. How are Category III AIFs taxed in India?
Category III AIFs are taxed at the fund level on all types of income — including capital gains, dividends, and business income. The fund pays the applicable tax before distributing post-tax returns to investors, who are not taxed again on such distributions.
Q2. Are investors in Category I and II AIFs taxed?
Yes. These AIFs enjoy pass-through status, so investors pay tax directly on gains in their personal returns.
Q3. What is the current long-term capital gains (LTCG) tax on AIFs?
Post Finance Act 2024, LTCG is taxed at 12.5% for listed securities exceeding ₹1 lakh.
Q4. How is business income treated under AIF taxation?
Business income earned by an AIF is taxed at the fund level at the Maximum Marginal Rate (~42.74%) — this applies to all AIF categories; however, only Category III AIFs are taxed at the fund level on all types of income.
Q5. Which AIF category offers the best tax efficiency?
Category II AIFs are generally preferred for their pass-through structure and diversified asset mix.
Category II AIFs offer the best tax efficiency in India, as they enjoy full pass-through status—income is taxed directly in investors’ hands, avoiding double taxation. Category III AIFs, by contrast, are taxed at the fund level. However, when structured within IFSC (GIFT City), even Cat-III AIFs gain significant exemptions—zero capital-gains tax for non-residents and lower fund-level taxes—making them highly tax-advantaged for global investors.
Conclusion
AIF taxation in India varies across categories and structures.
While Category I and II AIFs offer investor-level pass-through benefits, Category III AIFs pay taxes at the fund level.
Understanding these nuances helps investors align fund choice with their tax planning goals and optimize after-tax returns.
With a disciplined, research-backed approach, Aequitas continues to help investors navigate the evolving AIF tax landscape effectively and offer cat-3 AIFs in India and Global Equities.
