Withholding tax
Also written Withholding of tax · Withholding tax on AIF distributions · TDS by an AIF
Tax 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.
In plain language
The government does not like waiting. So for many kinds of income it collects the tax from the payer, before the money reaches the person who earned it.
That deduction is withholding tax. The workbook's own definition is short: a sum deducted from any income paid or credited.
It is not an extra tax. It is the same tax, collected early and by somebody else. The investor gets credit for it in their own return of income. If too much was withheld, the refund comes later.
Two separate questions run through this topic, and candidates mix them up. First, does the AIF withhold when it distributes money to its investors? Yes. Second, does the portfolio company withhold when it pays money to the AIF? Mostly no.
How it works
Withholding by the AIF (section 14.1.9). Under section 393 of the ITA, an Investment Fund must withhold tax on income distributed to its investors, at these rates:
| Investor | Income | Rate |
|---|---|---|
| Resident | all income other than business income | 10% |
| Non-resident | dividend | 20% |
| Non-resident | other income | rates in force — the Finance Act of the relevant year, or the applicable DTAA rate |
Investors are entitled to claim credit of the taxes so withheld in their own returns of income.
Withholding by the Indian portfolio companies (section 14.1.10). Under the same section 393 and a CBDT notification dated 25 June 2015, the payer of income to an Investment Fund is not required to withhold any tax while paying or crediting income other than business income to that fund. The consequence the workbook draws is explicit: the investment fund would not suffer any withholding of taxes from its non-business income.
So the deduction happens on the way out of the fund, not on the way in.
The paperwork that follows (section 14.1.11). The Investment Fund must file its own return of income. The statement of income paid or credited by an Investment Fund to a unit holder for a tax year must be furnished to the unit holder by 30 June of the following financial year, in Form No. 78, duly verified.
Where a treaty comes in. For a non-resident, the rate in force may be displaced by the DTAA rate. To claim treaty benefit the non-resident must obtain a Tax Residency Certificate from the foreign tax authority, furnish any other prescribed information, and file Form 41 electronically along with the TRC.
A worked example
The fund and amounts are illustrative; the rates, sections and forms are the workbook's.
Meridian Absolute Return Fund distributes Rs 100 crore for the tax year. Units are held 70% by residents and 30% by one non-resident corporate investor. None of the distributed income is business income.
Resident investors — Rs 70 crore. Withholding at 10% = Rs 7 crore. They receive Rs 63 crore and claim credit for Rs 7 crore in their returns. An individual in a higher bracket pays the balance; one below the threshold claims a refund.
The non-resident — Rs 30 crore, of which Rs 8 crore is dividend and Rs 22 crore is interest.
| Component | Basis | Tax withheld |
|---|---|---|
| Dividend, Rs 8 crore | 20% for a non-resident | Rs 1.60 crore |
| Interest, Rs 22 crore | rates in force, or the DTAA rate if lower | per the Finance Act or treaty |
If the investor produces a Tax Residency Certificate and files Form 41, and its treaty gives a lower rate on interest, the treaty rate applies instead of the rate in force. Without the TRC, the beneficial rate is not available and the ITA rate stands.
Now look at the other direction. During the same year the fund received Rs 46 crore of interest and dividend from its Indian portfolio companies. None of those companies withheld anything, because the CBDT notification relieves a payer of income — other than business income — to an Investment Fund from withholding. So the fund suffered nil withholding on the way in and deducted Rs 8.60 crore on the way out.
By 30 June of the next financial year, the fund issues every unit holder a Form No. 78 statement of the income paid or credited.
Why NISM asks about it
Chapter 14, sections 14.1.9 (Withholding of tax by an AIF), 14.1.10 (Withholding of tax by the Indian portfolio companies) and 14.1.11 (Reporting compliances). Withholding is named in the chapter's own learning objectives, and Chapter 14's third sample question is the bare definition: Withholding tax means ______ — the answer is a sum deducted from any income paid or credited, against distractors about undisclosed income, penalties for withholding information, and tax carried forward.
Beyond the definition, expect the two rates (10% resident, 20% non-resident dividend), the fact that the portfolio company does not withhold, and the Form No. 78 statement due by 30 June.
Common exam traps
- 10% and 20% attach to different people, not different incomes. 10% is the resident rate on all non-business income; 20% applies to a non-resident and only where the distribution is dividend.
- For a non-resident's non-dividend income there is no single rate. The answer is rates in force — the Finance Act, or the treaty rate. A question offering a fixed percentage for that row is testing whether you read the sentence.
- Withholding is not a final tax. Investors claim credit in their returns. It is collection, not assessment.
- The portfolio company does not withhold on payments to the fund for non-business income. Candidates assume tax is deducted at every hop; here it is deducted once, on distribution.
- Business income is outside the resident 10%. It is dealt with at the fund under section 224 and exempt for the investor.
- Form No. 78 by 30 June, Form 41 for treaty benefit. Two different forms doing two different jobs.
- The retail TDS page is a different context. TDS — Tax Deducted at Source is written from a personal-finance paper and deals with bank deposit interest. Same mechanism, different rates and different payer.
Where this is taught
Free preparation for NISM Series XIX-ERelated terms
- Advance taxTax paid during the financial year itself, rather than after it ends — mandatory once the total tax liability for the year exceeds Rs 10,000, which catches most profitable ETIRD traders.
- Double Taxation Avoidance AgreementA treaty between two or more countries that prevents the same income being fully taxed twice, either by allocating the taxing right or by the residence country giving credit for tax paid at source.
- Non-ResidentAn assessee who fails every residency test in section 6 — taxable in India only on income received, accruing or deemed to accrue in India, and on nothing that arises abroad.
- Tax Residency CertificateThe certificate a non-resident investor obtains from its home tax authority to claim benefits under a Double Taxation Avoidance Agreement — without it, Indian domestic rates apply.
- Investment FundUnder 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.
- Tax yearUnder the Income Tax Act, 2025, the 12-month financial year beginning 1 April — or, for a newly set-up business or profession, the period from set-up to the end of that financial year.
- TDS — Tax Deducted at SourceTax the bank deducts before crediting certain interest to you — absent on savings bank interest but charged on fixed and recurring deposit interest beyond a stipulated amount the workbook does not state.
- 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.