India: Tax Pass Through For Alternative Investment Funds: Clarification Needs Little More Clarity

  • CBDT issues circular seeking to provide clarity on the tax treatment of alternative investment funds that are set up as trusts.
  • In order to qualify as a 'determinate trust', the names of all investors in an AIF and their beneficial interests should be expressly stated in the trust deed on the 'date of its creation'.
  • 'Date of creation' needs greater clarity as the fund formation requires multiple closings and investors get added from time to time.
  • AIFs which do not fulfill the requirements laid down by the CBDT will be taxed at the maximum marginal rate in the hands of the trustee of the AIF. Ambiguity around the applicable rate of tax for capital gains
  • CBDT circular to impact the availability of treaty benefits to offshore investors in an AIF and impact fund raising and fund operations of AIFs.
  • Where capital is raised both offshore and onshore, co-investment structures may be preferred in comparison to unified investment structures going forward.

The Central Board of Direct Taxes ("CBDT") issued a circular1 dated July 28, 2014 ("Circular") to provide 'clarity' on the taxation of alternative investment funds ("AIFs") that are registered under the Securities and Exchange Board of India (Alternative Investment Funds) Regulations, 2012 ("AIF Regulations").

The Circular states that if 'the names of the investors' or their 'beneficial interests' are not specified in the trust deed on the 'date of its creation', the trust will be liable to be taxed at the 'maximum marginal rate'.

This poses some serious questions for the Indian fund industry that typically have multiple 'closings' where where subsequent round investors participate in the fund, may be impacted. Further, even with a single closing, owing to natural and other consequences such as termination of an investor's participation in distributions made by the fund where they default in making contributions or transfer of fund units from one investor to another, there could be revisions in the beneficial interests of investors.


A 'trust' is a vehicle of choice when setting up pooling structures in India. This is largely driven by the fact that the Indian Trust Act, 1882 allows a trust to be effectively structured as a functional equivalent of a limited partnership, as available in other jurisdictions.

The AIF Regulations provide the regulatory framework for privately placed domestic funds in India and was introduced by Securities and Exchange Board of India ("SEBI") to recognize AIFs as a distinct asset class. SEBI classifies AIFs in 3 distinct categories to tie concessions and incentives to investment restrictions.

Category I AIFs encompass AIFs with a defined investment strategy focusing on Venture Capital Funds, Small and Medium Enterprises Funds, Social Venture Funds and Infrastructure Funds, which in SEBI's view, lead to "... positive spillover effects on the economy".

Category II AIFs encompass AIFs that may not need any focused incentives. These would include private equity funds and debt funds.

Category III AIFs could be used to set up an onshore hedge fund structure with prescribed levels of leverage.


Post the Finance Act, 2012, income is made taxable directly in the hands of investors (of Venture Capital Funds) on an accrual basis and the pooling vehicle is not to be subject to any tax.

The AIF Regulations and the Finance Act, 2013 limit the benefit of this 'pass - through' only to the Venture Capital Fund sub-category of Category I AIF. Therefore, the pass-through status is limited only to AIFs, which invest primarily in unlisted securities of start-ups, emerging or early stage ventures mainly involved in new products, new services, technology or intellectual property right based activities or a new business model. There are no explicit provisions that allow various other funds, such as Social Venture Funds, Infrastructure Funds and SME Funds, which also fall within AIF Category I to get a pass-through benefit. Further, Category II and III AIFs will also not be entitled to the tax pass-through status.

Consequently, a majority of AIFs are structured as trusts to avail of tax pass-through under general trust taxation provisions. In such a scenario, the concerned funds rely and seek to be taxed as per the general principles of taxation of trusts viz. sections 161 to 164 of the Income Tax Act, 1961 ("Tax Act") which allow for a pass-through taxation for determinate trusts.

As per Explanation 1 to section 164 of the Tax Act, a trust is considered to be a determinate trust if it fulfills the following two conditions:

  • Beneficiaries of the income arising to the trust are identifiable on the date of the trust deed; and
  • The share of income of each beneficiary is ascertainable on the date of the Indenture.

Where the trust (the fund) is determinate, i.e., the beneficiaries are identifiable with their shares being determinate, the trustee is assessed as a representative assessee and tax is levied on and recovered from them in a like manner and to the same extent as it would be leviable upon and recoverable from the person represented by them (i.e. the investors to the concerned fund). In the case of AIG (In Re: Advance Ruling P. No. 10 of 1996), the Authority for Advanced Rulings ("AAR") held that it is not required that the exact names of all the beneficiaries are stated in the trust deed or the exact shares of the beneficiaries be specified for a trust to be considered a determinate trust; as long as there is no uncertainty regarding the beneficiaries and no uncertainty regarding the share of income to which they are entitled, the trust will still be treated as a determinate trust even if there is a pre-determined formula by which distributions are made and pre-determination of the class of persons who become beneficiaries of the trust. If a trust is not considered to be determinate, the income of the trust will be taxed at the maximum marginal rate in the hands of the trustee in its capacity as the representative assesse of the beneficiaries.

Several participants of the onshore funds industry have been making representation to the tax authorities seeking clarity on various issues relating to the taxation of onshore funds that are excluded from the coverage of Section 10(23FB) of the Tax Act including the requirements that need to be fulfilled to qualify as a determinate trust.


What attributes 'determinate' status to an AIF and position of tax if a concerned AIF is not 'determinate': The Circular provides that in situations where the trust deed of an AIF on the date of its creation either (1) does not name the investors (i.e. the beneficiaries) or (2) does not specify the beneficial interests of such investors, the provisions of section 164(1) of the Tax Act would come into play and the entire income of the AIF shall be liable to be taxed at the maximum marginal rate in the hands of the trustee of the AIF in its capacity as 'representative assessee' of the trust.

If part or all of the income of the AIF is in the nature of business income: The Circular states that where the income of an AIF consists of, or includes, profits and gains of business, section 161(1A) of the Tax Act would take effect and the whole of the income of the AIF would be taxed in the hands of the trustee in its capacity as a 'representative assessee' of the AIF at the maximum marginal rate even where the AIF is determinate.

Tax pass – through status: Given the position under the Circular, it would appear that in respect of AIFs other than Category I AIFs (in the venture capital fund sub-category) to whom the provisions of section 10(23FB) of the Tax Act applies, a position of tax 'pass – through' can be maintained if (1) the AIF is determinate (i.e. the names of the investors and their beneficial interests are stated in the trust deed 'on the date of its creation') and (2) the income of the AIF does not consist of or include profits and gains of business.

Interestingly, it has also been provided that the clarifications contained in the Circular shall not be operative in an area falling in the jurisdiction of a High Court which has taken or takes a contrary decision on the issue.


The Circular is likely to impact the tax treatment applicable to certain kinds of income streams of an AIF. For instance, long-term capital gains arising to an AIF on the transfer of unlisted securities is typically taxed at the rate of 20% (with indexation benefits). Similarly, long-term capital gains arising to an AIF on the transfer of listed securities on which securities transaction tax ("STT") has not been paid is taxed at the lower rate of 10% (without indexation benefits) or 20% (with indexation benefits). As a consequence of the Circular, such income may now potentially be taxed at the maximum marginal rate in the hands of the representative assessee (i.e. the trustee).

Offshore investors: Investors (including feeder funds) based out of a jurisdiction which has a favourable tax treaty with India may not be able to place reliance on the provisions of the applicable tax treaty unless the AIF meets the requirements of being 'determinate' as clarified by the Circular, failing which, the AIF will not be regarded as a tax pass-through entity. Ideally, both for computation of income and determination of tax on the computed income, the characterization of income in the hands of the trustee to the AIF should be the same as in the hands of the beneficiary (i.e. each investor to the AIF).


The clarification provided under the Circular on the requirements to be fulfilled to qualify for 'determinate trust' status may have implications on the operation of AIFs. Some of the possible implications are discussed below.

Multiple closings

As per the Circular, an AIF that is looking to qualify as a determinate trust is required to state the names of its investors and their beneficial interests in the trust deed on the date of creation of the trust. Accordingly, such AIF may not be able to on-board new investors at a subsequent closing since this will require the trust deed to be amended and this is turn would mean that the identities of the investors and their beneficial interests will not be the same as on the date of creation of the trust.

Change in beneficial interests of investors

In an AIF, there are several circumstances in which the beneficial interests of investors could vary. For instance, part transfer of unit holding from one investor to another would alter the beneficial interests of both investors in the AIF. Further, the termination of a defaulting investor's participation in an AIF would result in a realignment of beneficial interests of the remaining investors. On June 19, 2014, SEBI issued a circular stating that where there was a material change in the placement memorandum, AIFs would be required to provide an exit option to investors who did not wish to remain invested in the fund. To the extent that any investor availed the exit option, there would be a realignment of the beneficial interests of the remaining investors.

Impact on fundraising

Since an AIF will retain its status as a determinate trust only if the names of the investors and their beneficial interests are known on the date of creation of the trust, an AIF (seeking to qualify as a determinate trust) may be restricted with respect to the innovations to the distribution and fee mechanisms that it can offer investors.

In particular, the use of opt-in and opt-out clauses may trigger taxation at the maximum marginal rate in the hands of the trustee. Such AIFs will need to raise its entire corpus at the initial closing so as to ensure that the names of its beneficiaries and their beneficial interests are known on the date of creation of the trust.


The Circular may have been issued with an intention to clarify the tax position for onshore funds set up as AIFs. At present, a substantial majority of AIFs have been structured as trusts and map the identities and beneficial interests of their investors, based on the principles laid down in AIG (In Re: Advance Ruling P. No. 10 of 1996) i.e by providing for the manner of determining the beneficiaries (such persons who sign up the contribution agreement) and for determining their beneficially interest through a formula based approach. Such AIFs may be impacted by the clarification provided by the Circular.

Globally, investment funds rely on a 'tax pass-through status' wherein the income of the investment fund is taxed directly in the hands of its investors, but not at the level of the fund itself. This provides fiscal neutrality to the funds as it eliminates tax at the pool level while maintaining taxation at the investor level.

Accordingly, what is required to be clarified now in the context of trusts is ‎if the beneficiaries can be identified 'at any point in time' and their shares are ascertainable, the trust should be considered pass through. This would be in line with ruling laid down by the AAR in AIG. The requirement laid down in the Circular of explicitly stating the names of the investors of the AIF and their beneficial interests on the date of creation of the trust creates ambiguity. In fact the AIG ruling had specifically commented on each of these aspects in great detail which ought to have been replicated in the Circular in order to remove all ambiguities on the issue.

One open alternative that may still be available in a fund context is that in the event that the capital contributions of the investors in an AIF are treated as revocable, then as per the provisions of section 61 of the Tax Act, any income of the AIF is taxable directly in the hands of such investors. This could also help in making out a defendable case for treating such structures as being tax pass-through, though there are no decisions in the context of funds that are available today in this regard. It was hoped that the Circular would provide finality and remove all ambiguities on the pass through treatment for AIFs, but instead we are left with a situation where there are more questions that are being raised.


1 Circular No. 13 / 2014 dated July 28, 2014

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on

Click to Login as an existing user or Register so you can print this article.

Richie Sancheti
In association with
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.


Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.


Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.


A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.


This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.


If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.


This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at and we will use commercially reasonable efforts to determine and correct the problem promptly.