Investment Fund
Under Section 115UB, a Category I or Category II AIF (or an IFSCA-regulated fund) established in India — the only AIFs given tax pass-through. Category III AIFs are outside the definition.
In plain language
In Indian tax law, "Investment Fund" is not a casual phrase. It is a defined term in Section 115UB of the Income Tax Act, 1961, inserted by the Finance Act, 2015, and it decides which AIFs get tax pass-through status.
Pass-through means the AIF is not obliged to pay income tax on the income it generates; its investors pay tax on it instead, in their own returns. Section 115UB grants this to an Investment Fund: income accruing to or received by a unit holder of an Investment Fund is taxed as if the unit holder had earned it directly.
The definition covers any fund established or incorporated in India as a trust, company, LLP or body corporate holding a certificate of registration as a Category I or Category II AIF under the SEBI (AIF) Regulations, 2012, or regulated under the IFSCA (Fund Management) Regulations, 2022. Category III is not in the list — so Category III AIFs are not Investment Funds and do not get pass-through.
How it works
How the income is split — Section 115UB read with Sections 10(23FBA) and 10(23FBB):
| Income head | Taxed where |
|---|---|
| Profits or gains from business or profession | In the Investment Fund; exempt in unit holders' hands under 10(23FBB) |
| Capital gains, income from other sources | Exempt at fund level under 10(23FBA); taxed in unit holders' hands at their applicable rates |
Rate on the fund's taxable income — Section 115UB(4). A fund formed as a company or LLP pays at company or LLP rates. A fund formed as a trust pays at the Maximum Marginal Rate, which the workbook gives as currently 30%.
Losses — Section 115UB(2), as amended
- Business losses stay in the fund and are carried forward and set off there.
- Other losses are not passed through to unit holders in respect of units held for less than 12 months.
- Non-business losses accumulated in the fund at 31 March 2019 are deemed losses of unit holders holding units on that date, who may carry them forward until 8 years from the year the fund first incurred them.
- Losses deemed to be unit holders' are no longer available to the fund.
What it means for Category III. Because it is not an Investment Fund, a Category III AIF's tax position depends on its legal form and, for a trust, on whether it is determinate or indeterminate and revocable or irrevocable.
A worked example
Illustrative figures. Two AIF trusts earn identical income in a year:
| Income | Rs crore |
|---|---|
| Long-term capital gains | 12 |
| Interest | 3 |
| Business income | 2 |
| Total | 17 |
Fund A — a Category II AIF, therefore an Investment Fund
Taxed in the fund: business income Rs 2 crore at MMR 30% = Rs 60 lakh
(before surcharge and cess)
Passed through: Rs 12 crore + Rs 3 crore = Rs 15 crore
taxed in unit holders' hands at their own rates
An investor holding 10% of Fund A reports Rs 1.2 crore of capital gains and Rs 30 lakh of interest in her own return, and pays nothing on the fund's business income.
Fund B — a Category III AIF, not an Investment Fund. Section 115UB does not apply at all. Fund B's treatment turns on its trust structure. The workbook's Chapter 9 worked example (Fund TI, an irrevocable determinate trust) shows the fund itself paying tax — at MMR on business income, and at MMR with surcharge and cess on dividend income treated as income from other sources.
Why NISM asks about it
Chapter 9 (Taxation) opens with Section 115UB and the Investment Fund definition in 9.1, including 10(23FBA), 10(23FBB), the trust rate and the loss rules. Chapter 3 flags early that Category III AIFs, unlike Categories I and II, are not entitled to pass-through. Expect a True/False on whether Category III AIFs qualify, and a question on which income is taxed at fund level.
Common exam traps
- Category III AIFs are not Investment Funds. Section 115UB names only Category I and II (and IFSCA-regulated funds).
- Business income is taxed in the fund; other income passes through. The two exemption sections work in opposite directions.
- A trust Investment Fund pays at MMR, stated as 30%; company and LLP funds pay at their own rates.
- Losses do not pass through freely: business losses stay in the fund; other losses do not pass through on units held under 12 months.
- 31 March 2019 losses are deemed unit holders' and carry forward for up to 8 years.
- Category III tax treatment — the workbook contradicts itself. Section 9.1 says a Category III AIF's income is taxed at MMR in the hands of the fund because pass-through is not accorded; section 9.3 says that for an irrevocable determinate trust, capital gains and income from other sources are eligible for a tax pass-through, with beneficiaries taxed at their applicable rates. Know which section a question is drawing on.
Check yourself
1.Under sub-section (4) of Section 115UB, how is the total income of an Investment Fund charged to tax?
- a)If formed as a company or LLP, at the rates applicable to a company or LLP; if formed as a trust, at the Maximum Marginal Rate, currently 30 per cent
- b)At a flat 15 per cent, whatever the legal form of the fund
- c)If formed as a trust, at the slab rates applicable to the settlor
- d)If formed as a company, at the Maximum Marginal Rate; if formed as a trust, at company rates
Show the answer
Answer: (a) If formed as a company or LLP, at the rates applicable to a company or LLP; if formed as a trust, at the Maximum Marginal Rate, currently 30 per cent
The workbook quotes sub-section (4): ‘Where the Investment Fund is formed as a Company or a Limited Liability Partnership (LLP), total income of such Investment Fund shall be charged to tax, as per the rates applicable to Company or an LLP’ and ‘Where the Investment Fund is formed as a Trust, total income of such Investment Fund shall be charged to tax, at the Maximum Marginal Rate (MMR), currently at 30%’.
- No flat 15% rate exists. 15% is the surcharge under Sections 111A and 112A.
- The settlor's slab rates are never mentioned. A trust is charged at MMR.
- Option (d) swaps the two rules.
Remember too that Section 115UB's definition of Investment Fund covers only Category I and Category II AIFs. A Category III AIF set up as a trust is taxed at MMR in the fund's hands because it does not get pass-through status.
2.Capital loss accumulated at the level of a Category III AIF as on 31 March 2019 may be:
- a)set off only by the fund, never by unit holders
- b)deemed to be the loss of a unit holder who held units as on 31 March 2019, carried forward for eight years from the year the loss was first incurred
- c)carried forward indefinitely by the fund
- d)passed through only if the units were held for less than twelve months
Show the answer
Answer: (b) deemed to be the loss of a unit holder who held units as on 31 March 2019, carried forward for eight years from the year the loss was first incurred
This is the workbook's own sample question, stated as True. Losses other than business loss accumulated at the level of investment fund as on 31st March, 2019, shall be deemed to be the loss of a unit holder who has held units in the fund as on 31st March, 2019, and he shall be allowed to carry forward the loss in his returns, until the expiry of 8 years from the year in which the loss was first incurred. Once so deemed, such losses shall not be available to the investment fund. Option (d) inverts the rule — losses other than business losses do not pass through where units were held for less than 12 months.
3.A Category III AIF is denied tax pass-through status because:
- a)it is prohibited from being formed as a trust
- b)the definition of Investment Fund in Section 115UB covers only Category I and Category II AIFs
- c)it invests in derivatives
- d)its investors are high net-worth individuals
Show the answer
Answer: (b) the definition of Investment Fund in Section 115UB covers only Category I and Category II AIFs
Section 115UB defines an Investment Fund as a fund in India formed as a trust, company, LLP or body corporate which has been granted a certificate of registration as a Category I or a Category II Alternative Investment Fund. Accordingly, Category III AIFs are not considered as Investment Funds and hence, not accorded the tax pass-through status, and the income earned by such a fund is taxed at the Maximum Marginal Rate, in the hands of the Fund. The exclusion is definitional, not a consequence of what the fund invests in or who invests in it.
Where this is taught
- Series XIX-B · Chapter 9: Taxationintroduced here
- Series XIX-C · Chapter 16: Taxationintroduced here
- Series XIX-E · Chapter 14: Taxationintroduced here
- Series XIX-D · Chapter 13: Taxationintroduced here
Related terms
- Category III AIFThe AIF category for funds running diverse or complex trading strategies with leverage — hedge funds and their kin — and the only category denied tax pass-through status.
- Determinate trustA trust whose beneficiaries and their beneficial interests are ascertainable from the trust deed throughout its life — the structure that lets a Category III AIF avoid MMR on non-business income.
- Category I AIFThe AIF category for funds the government or a regulator treats as socially or economically desirable — venture capital, angel, SME, social impact, infrastructure, special situation and CDMDF funds.
- Category II AIFThe residual AIF category: anything that is neither Category I nor Category III and takes no fund-level leverage beyond a narrow temporary carve-out — private equity, private debt and fund-of-funds.
- Maximum Marginal RateThe highest slab rate of income tax, applied to a Category III AIF's business income at fund level because the fund gets no pass-through — 30% before surcharge and cess.
- Representative AssesseeThe capacity in which the trustee of an AIF set up as a trust is assessed to income tax under Sections 161 and 164 — paying on behalf of the beneficiaries so the same income is not taxed twice.
- Pass-through statusTax treatment under which a fund's income is not taxed in the fund but directly in its investors' hands — and which the Income Tax Act does not give a Category III AIF.
- Equity-oriented Investment FundA Category III AIF that invests over 65% (or 90% via another fund) of its proceeds in listed domestic equity shares — taxed at 20% short-term and 12.5% long-term capital gains rates, per SEBI's AIPAC.
- Withholding taxTax deducted from income at the point it is paid or credited — for an AIF, 10% on income distributed to a resident investor and 20% where a non-resident is paid dividend.
- Alternate Minimum TaxA floor tax on non-corporate assessees — 18.5% of adjusted total income, 15% for a co-operative society — payable when it exceeds their normal tax, with the excess carried forward as credit for 15 years.
- National Investment and Infrastructure FundThe Government of India's own alternative investment fund, set up in 2015 as a Category II AIF to invest in infrastructure and strategic assets.
- Specified Alternative Investment FundThe fourth registration category SEBI inserted in 2023 for AIFs that fit none of Categories I, II and III, and for which SEBI may specify separate regulations.