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Tata Capital > Blog > Wealth Services > Taxation rules for AIF in India

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Taxation rules for AIF in India

Taxation rules for AIF in India

AIF or Alternative investment funds are quite different from the traditional investment options. These are pooled investment vehicles (privately held) and HNIs and private investors invest in these funds mainly.

The taxation rules for AIF are also a little bit tricky and you need to be aware of them properly when investing in these funds. The tax implications are different for the different categories of AIF as well. In this article, we will be discussing the taxation rules on each of the AIF categories and other related aspects of it.

What is an AIF?

Alternative Investment funds (AIF) are funds which invest in hedge funds, private equity, venture capital, angel fund, REITs and many such alternative investment vehicles. These are specifically made for high net worth investors with customized investment needs. SEBI doesn’t regulate AIF but has listed some rules for AIF. Regulation 2(1) of the Regulation Act, 2012 of SEBI has those regulations pertaining to AIF. According to the regulation, AIF can be an established company in India, an LLP or a trust, and even a corporate body.

The information related to AIF is not easily available to the public in general. These are highly private funds handled by the fund members only. They are thus pretty illiquid as well. However, the transaction costs are the same as the turnover cost.

What are the different categories of AIF?

AIF has three different categories which are –

1. Category I (CAT I):

AIFs within this category invest in economically and socially viable start-ups and Small and Medium Enterprises (SMEs) through Venture Capital Funds (VCFs), Angel Funds, Social Venture Funds, and Infrastructure Funds.

2. Category II (CAT II):

AIFs that fall in this category invest primarily in viable equity and debt securities. This category includes private equity funds, funds for distressed assets, real estate funds, debt funds, and also fund of funds.  These funds are close ended and do not engage in leverage.

3. Category III (CAT III):

This Category of AIFs focuses on earning short-term returns through diverse or complex trading strategies.CAT III includes hedge funds and private investment in public equity funds (PIPE).

Additional Read: Taxation and the union budget. All you need to know

Taxation Rules for AIF in India

Before discussing the taxation rules on AIFs, it is imperative you know the factors impacting it. There are two of them:

  • Your AIF taxation will depend and vary with each category. Simply put, Categories I, II, III are all taxed differently.
  • The legal form of the AIF will also dictate the tax rules surrounding it. And, SEBI allows AIFs only in the form of a company, trust, or a limited liability partnership.

Tax implications on AIF (category wise)

Since the categories are different with different investment vehicles, the tax implications are also different for each of them. Let’s see the tax implication for each of them -


For CAT I & CAT II, there is a pass-through status. Tax pass-through status means that the income or loss (other than business income) generated by the fund will be taxed at the hand of the investor and not by the fund business. So, if you invest in these two categories of the AIF, then you need to pay capital gain tax on the profit or loss you make from the fund within a given duration. The duration here is important to understand whether long-term capital gain tax or short-term capital gain tax would be applied. As per the recent s rules for LTCG, 20% is the rate of tax with indexation benefit. If the profits are taxed as STCG, then the rate would be 15%. There are surcharge, cess charges on and above the mentioned tax rates as well. Any income (except business income) distributed by investment fund is not liable for DDT and TDS of 10% has to be deducted by investment fund.

Nature of Income earned by the FundTaxabilityTax Rate
Other than business income (for example: capital gains)Passed through - AIF doesn’t pay any tax. The unit holder pays the taxRates applicable to the unit holder
Business IncomeTaxed at AIF. Such income is not taxable for unit holdersAIF formed as company or LLP. Taxed at the rates applicable to the company or the LLP.

AIF formed as Trust: Taxed at Maximum Marginal Rate*.
*Maximum Marginal Rate for business income as per the latest tax rates enacted as of 2020 is 42.744%.


This category of funds is taxable at the fund level. This has no pass-through status. The highest rate of tax (as per the current tax slab) is charged on the profit made by this fund.

A Category III AIF pays tax on the following four types of incomes:

  • Short-term capital gains
  • Long-term capital gains
  • Business income 
  • Dividend income

Here is a table explaining how each source of income is taxed in category III AIF in India:

Tax typeShort-Term Capital GainsLong-Term Capital GainsBusiness IncomeDividend Income
Basic tax15%10%30%30%
Surcharge over tax15%15%37%37%
Education Cess4%4%4%4%

Additional Read: Let’s Understand the Difference between PMS and AIF


AIF is a very sophisticated investment vehicle and the taxation rules make them a little more complicated for general investors. But the crux of it is that if you are investing in CAT III funds, then you do not have to worry about the taxation rules as these funds are taxable at the fund level. However, with the other two categories that are CAT I and CAT II, you need to understand the tax implications before investing.

If you are looking to invest in any category of Alternate Investment Fund, you will need professional help. Reach out to Tata Capital Wealth and allow us to curate financial solutions around AIFs that maximise your personal or business wealth.

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