Revocable transfer

When investors put money into an AIF set up as a trust, the first tax question is not about the income at all. It is about the nature of the transfer: did the investors truly part with the money, or did they keep a way to take it back?

The workbook (section 14.1.1.1) says a transfer of an asset is revocable when the transfer document — for an AIF, typically the contribution agreement — contains a provision for:

• the re-transfer, directly or indirectly, of the whole or any part of the income from the asset to the transferor; or
• a right for the transferor to reassume power, directly or indirectly, over the whole or any part of the income or asset.

If either is present, the tax law looks through the trust. The income is taxed in the hands of the transferor — the contributors or settlor — under sections 97 and 98 of the Income Tax Act.

The first branch of the trust taxation tree (Chapter 14):

What the workbook says about AIFs in practice: if capital contributions are revocable under sections 97 and 98, the beneficiaries are liable to tax on the income attributable to those contributions; and typically, Category III AIFs are not structured as trusts with revocable transfer. Only if the transfer is irrevocable does the next question — determinate or indeterminate — arise.

The trust-law side (Chapter 6, section 6.3, Anatomy of AIF Constitution). Under the Indian Trusts Act, a trust can be revocable or irrevocable by the settlor: in a revocable trust the trust property can revert to the settlor; in an irrevocable trust ownership is permanently vested in the trust. For AIF purposes, an "irrevocably settled, determinate trust" is considered more appropriate, primarily for clear tax treatment.

The fund, clause and amounts are illustrative; the tax consequences follow the workbook.

A sponsor is drafting the contribution agreement for a Rs 400 crore Category III AIF set up as a trust. The draft contains this clause for an anchor investor committing Rs 80 crore:

That clause both re-transfers income to the transferor and lets it reassume power over the asset. The anchor's transfer is revocable.

Suppose the fund earns Rs 50 crore of income in a tax year. The anchor's share by contribution is:

80 ÷ 400 × Rs 50 crore = Rs 10 crore

That Rs 10 crore is taxed in the anchor investor's own hands under sections 97 and 98 — not in the trustee's hands as representative assessee.

The sponsor's tax adviser flags the problem: a single revocable clause pulls part of the fund outside the irrevocable, determinate structure the workbook recommends for clear tax treatment. The clause is removed; the anchor gets its liquidity through the scheme's normal redemption terms instead, and the transfer becomes irrevocable.

Chapter 14, section 14.1.1.1 (Trust Taxation Principles — Revocable v. Irrevocable transfer), gives the definition, sections 97 and 98, and the statement that Category III AIFs are typically not revocable. Chapter 6, section 6.3 (Anatomy of AIF Constitution), explains revocable and irrevocable trusts and why an irrevocably settled determinate trust is preferred. Chapter 14 sample question 1 asks which trust structure passes through capital gains to investors. Expect the two conditions, the section numbers and who is taxed.

• Revocable transfer: income taxed on the transferor, not on the trustee.
• Sections 97 and 98 for revocable transfers; section 304 for the trustee as representative assessee of a determinate trust.
• Either condition is enough: re-transfer of income, or a right to reassume power over income or asset — directly or indirectly, whole or part.
• Typically, Category III AIFs are not structured as revocable trusts.
• Determinate/indeterminate is only the second question, asked after the transfer is found to be irrevocable.
• The preferred AIF structure is an irrevocably settled, determinate trust — for clear tax treatment.
• Section numbers are under the Income Tax Act, 2025, as used in Chapter 14; other chapters of the workbook still refer to the 1961 Act.