AIF Taxation in India: Category I, II and III, Pass-through, TDS

AIF taxation in India turns on one question: who pays the tax, the fund or you? For Category I and II alternative investment funds the answer is mostly you, because the law gives them pass-through status. For Category III funds the answer is mostly the fund. This guide walks through AIF tax for FY 2026-27, the first year under the Income-tax Act, 2025, with the TDS, forms and paperwork that come with it.

For how the categories differ on tenure, leverage and minimums, see our guide to AIF Category I, II and III.

AIF tax at a glance

How Category I and II AIFs are taxed: pass-through

From section 115UB to section 224

Under the Income-tax Act, 1961, Category I and II AIFs were taxed under section 115UB; from 1 April 2026, the provision is section 224 of the Income-tax Act, 2025. The core rule reads almost the same: income from the fund is taxed as if you had made the fund's investments directly.

Section 224 defines an "investment fund" as a trust, company, limited liability partnership or body corporate in India that is registered as a Category I or II AIF under the SEBI (Alternative Investment Funds) Regulations, 2012, or regulated under the IFSCA (Fund Management) Regulations, 2022. Category III funds are outside this definition, which is why they are taxed differently. Category II funds, such as private equity, private credit and real estate funds, get the same pass-through treatment as Category I.

Income keeps its character

The fund's income reaches you with the same nature and in the same proportion as the fund earned it. A ₹10 lakh payout is not one lump of "AIF income". It might be ₹6 lakh of interest, ₹3 lakh of capital gains and ₹1 lakh of dividends, and each part is taxed under its own rules in your return.

For capital gains, the Finance Act, 2025 settled a long-running question with effect from FY 2025-26 (assessment year 2026-27) onwards: securities a Category I or II AIF holds in line with SEBI or IFSCA rules are capital assets. Gains on selling them are capital gains, not business income.

Business income stays at the fund level

The one exception to pass-through is business income, on which the fund itself pays tax. Section 224 sets the rate: the Finance Act rates if the fund is a company or a firm, and the maximum marginal rate in any other case, which includes a fund set up as a trust. That business income is not taxed again when it reaches you.

Income not paid out is still taxed in your hands

If the fund earns income during the year but does not distribute it, section 224 treats your share as credited to you on the last day of the tax year. You pay tax on it for that year, and it is not taxed again when the fund later pays it out.

How AIF capital gains, interest and dividends are taxed in FY 2026-27

Under pass-through, your own rates apply:

• Listed equity sold by the fund: 20% if held 12 months or less; 12.5% if held longer, with the first ₹1.25 lakh of such long-term gains in a year exempt in total.
• Interest, for example from a private credit fund, and dividends: taxed at your slab rate. Under the default regime, the top rate is 30% on income above ₹24 lakh.
• Surcharge and cess: surcharge starts once total income crosses ₹50 lakh and rises in steps, to a top rate of 25% under the default regime and 37% under the old regime. On capital gains from listed equity and on dividends, surcharge is capped at 15%. Health and education cess of 4% applies on tax plus surcharge.

Section 194LBB TDS on AIF payouts, now section 393

The 10% rule

Under the old Act, section 194LBB required the fund to deduct tax when it credited or paid income to you, whichever was earlier: 10% for residents and the rates in force for non-residents. From 1 April 2026, the same rule sits in section 393 of the Income-tax Act, 2025: Table 4(iii) of section 393(1) sets 10% for residents with no threshold, and Table 8 of section 393(2) covers non-residents at the rates in force.

TDS applies only to the taxable part of a payout: the business income portion, already taxed in the fund and exempt in your hands, is left out.

TDS is not your final tax

The 10% is an advance collection, not your final bill. In the 30% slab, interest income needs more tax through advance tax or self-assessment; if your tax is lower than the TDS, you claim a refund. A lower or nil deduction certificate, earlier under section 197, is now applied for under section 395(1) on Form 128.

What Form 64C and Form 78 show for AIF investors

Every Category I and II AIF must give you a statement of the income it paid or credited during the year, broken down by type: business income, long-term and short-term capital gains, dividends and other income.

• Form 78 (earlier Form 64C) goes to you by 30 June after the tax year.
• Form 79 (earlier Form 64D) goes to the Income Tax Department by 15 June, filed electronically and verified by a chartered accountant.

Both sit under Rule 145 of the Income-tax Rules, 2026, which replaced Rule 12CB. Income of FY 2025-26 and earlier is still reported on Forms 64C and 64D; income of FY 2026-27 onwards on Forms 78 and 79. In your return, this income goes into the pass-through income schedule (Schedule PTI in the current forms), using the figures in the form, not the amount that landed in your bank account.

How AIF losses are treated for tax

Losses follow the same split as income:

• Business losses stay inside the fund. The fund carries them forward and sets them off against its own future business income. They never reach you.
• Other losses, such as a capital loss, can pass through to you, but only if you have held the AIF units for at least 12 months.
• Legacy losses, other than business losses, that had built up in the fund as of 31 March 2019 were treated as losses of the investors who held units on that date, for the remaining carry-forward period.

Once a loss reaches you, the normal set-off and carry-forward rules for your own return apply. Form 78 shows the loss figures you can use.

How Category III AIFs are taxed

No pass-through

Category III AIFs are not "investment funds" under section 224, so neither the pass-through rule nor the 10% TDS provision applies to them. Tax is paid by the fund, and what you receive is what remains after that tax and the fund's fees.

Many Category III funds are set up as trusts. Where a trust is taxed at the maximum marginal rate, the effective rate is about 39% including surcharge and cess under the default regime, where surcharge tops out at 25%. Some commentary uses 42.744%, which applies the old regime's 37% surcharge. It can be lower on listed equity gains and dividends, where surcharge is capped at 15%, and depends on the structure and the kind of income. A 2025 Delhi High Court ruling held that not naming investors in an AIF trust's original deed does not, by itself, make the trust "indeterminate", which matters because an indeterminate trust is taxed at the maximum marginal rate, so the position can differ from fund to fund.

What you receive net

Compare Category III returns after fund-level tax, not before. How a gain on redemption is treated in your hands depends on the fund's structure, and specialist commentary calls it unsettled, so read the tax section of the placement memorandum and ask your chartered accountant. For how Category III long-short funds compare with SIFs and PMS on cost and tax, see Category III AIF long-short funds vs SIF vs PMS.

A worked example with round numbers

Assume you are a resident individual in the 30% slab under the default regime, with total income below ₹50 lakh so surcharge does not apply, and you have already used your ₹1.25 lakh long-term gains exemption elsewhere. In FY 2026-27, a Category II AIF credits you ₹10 lakh: ₹6 lakh of interest and ₹4 lakh of long-term capital gains on listed shares it sold.

• TDS at 10%: ₹1,00,000. You receive ₹9 lakh in cash.
• Tax on interest at 30%: ₹1,80,000.
• Tax on long-term capital gains at 12.5%: ₹50,000.
• Total before cess: ₹2,30,000. With 4% cess: ₹2,39,200.
• Less TDS already deducted: ₹1,00,000. Balance you pay: ₹1,39,200.

Now take ₹10 lakh of income attributable to your units in a Category III trust that is taxed at the maximum marginal rate, which is 39% under the default regime (42.744% where the old-regime surcharge is applied). At 39%, the fund pays ₹3,90,000 and ₹6,10,000 stays in the fund for you. These illustrate mechanics only; your figures depend on the fund's income mix, your other income and your tax regime.

How AIF income is taxed for NRIs

For an NRI in a Category I or II AIF, pass-through still applies: your share of income is taxed in India as if you had invested directly. Tax is deducted at the rates in force for non-residents under section 393(2), rather than the 10% resident rate. If India has a tax treaty with your country of residence, a lower treaty rate may apply when you give the fund a Tax Residency Certificate and the declarations it asks for. A lower deduction certificate under section 395(1) is another route. Check how your home country taxes the same income too.

How GIFT City Category III funds are taxed differently

A Category III AIF in the International Financial Services Centre at GIFT City follows a different rule. If its units are held only by non-residents, apart from the sponsor or manager and a limited exception for investors who later become resident, it can qualify as a "specified fund" under Schedule VI of the Income-tax Act, 2025 (section 10(4D) of the old Act). Certain income, such as gains on some transfers on an IFSC stock exchange and income from securities issued by non-residents, is then excluded from the fund's income to the extent it belongs to non-resident unit holders. Schedule VI also excludes the unit holder's income from such a fund or from transfer of its units.

Because the test looks at who holds the units, a fund open to resident investors generally will not qualify, so a resident investing through the Liberalised Remittance Scheme should not assume this exemption applies; the fund's tax disclosures and your chartered accountant can confirm the position. Our GIFT City funds guide covers who can invest and how.

What your chartered accountant needs from you

1. Form 78 from each Category I or II AIF (Form 64C for FY 2025-26 and earlier), with the income split by type and any loss figures.
2. Your tax credit statement from the income-tax portal, to match the fund's TDS.
3. Capital call, distribution and unit statements, with allotment dates, so the 12-month test for losses can be checked.
4. Redemption statements from any Category III fund, with dates and amounts.
5. For NRIs: your Tax Residency Certificate, treaty declarations and any lower deduction certificate.

How Sanriya helps with AIF investments

Sanriya Finvest Pvt. Ltd., Pune, is an AMFI-registered mutual fund distributor (ARN-193359) and an APMI-registered PMS distributor (APRN01056). On AIFs, we explain how each category is taxed, share the placement memorandum and tax disclosures, handle onboarding and capital call paperwork, and follow up on statements such as Form 78 for your chartered accountant. We work as a distributor: the decision, and your tax position, stay with you and your chartered accountant. Contact us to talk through an AIF you are considering.