Budget 2025 | Tax relief for AIFs as income will now be treated as capital gains

This means that AIF income, previously treated as business income, will now be considered capital gains. While capital gains are taxed at 12.5%, the highest business income tax slab is 30%.

The amendment is significant given that, according to data from the Securities and Exchange Board of India (Sebi), more than 1,400 AIFs in the country had raised a cumulative ₹5 trillion as of September 2024.

AIFs are pooled investment vehicles for institutional and high-net-worth individual investors, managed by a general partner or fund managers for a fee and a portion of the profits. These vehicles, commonly known in India as private equity and venture capital funds, invest primarily in unlisted early to growth-stage companies.

The memorandum of the Finance Bill 2025 elaborates on how the definition of capital asset has been amended to address uncertainty around whether income arising from transacting in securities is capital gain or business income for category I and II AIFs.

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“With a view of providing certainty in respect of the above, it is proposed to amend the Act to provide that any security held by investment funds, which has invested in such security in accordance with the regulations made under the Securities and Exchange Board of India Act, 1992 would be treated as capital asset only so that any income arising from transfer of such security would be in the nature of capital gain,” the memorandum said.

This also has implications on the carry or profits earned by the managers of these funds, which will now be treated as capital gains, instead of income.

“The effect of this proposed amendment (potentially), under the present scheme of ‘pass-through’ taxation, would be that when the fund manager receives income on disposal of the portfolio company, the gains will be deemed as capital gains and as such the same characterization should continue for the fund manager,” said Ritesh Kumar, partner at consulting firm BDO. “If this interpretation was to hold up, this provides the much-sought certainty for the Indian funds industry.”

The amendment addresses one of the biggest pain points of the AIF industry.

“This means that all gains emanating from the sale of securities will always be treated as capital gains, not business income. Through this, Indian AIFs have achieved parity with the FPIs (foreign portfolio investors)–who got this treatment in 2014,” said Siddarth Pai, founding partner and CFO, 3one4 Capital, a homegrown venture capital firm. “This will increase tax certainty of AIF income.”

Sanjay Sanghvi, partner at law firm Khaitan & Co., said, “Currently, any income, apart from business income earned by Category I or II Alternate Investment Funds (AIFs), is taxed on a pass-through basis in the hands of the investors. There was uncertainty among the industry as to whether the income earned by such AIFs can be treated as ‘business income’ given the nature and frequency of the activities undertaken by such AIFs.”

This amendment reduces tax ambiguity and ensures consistent treatment for AIF investors in line with FIIs, Sanghvi said. “Amendment is effective for FY 2025-26 and onwards; accordingly, there may be a debate on the applicability of these provisions for the earlier years though.”

No TDS, TCS

The budget also exempted these funds from tax collected at source or TCS, leading to tax savings, investors and industry experts told Mint.

To rationalise the tax deducted at source (TDS) and tax collected at source (TCS) regimes, the government removed Section 206C (1h) from 1 April 2025. This means that the sale of securities by an AIF and others will no longer be subject to TCS, addressing another long-pending industry demand.

The government previously announced a fund of funds (FoF) allocation of ₹10,000 crore to provide capital support to these AIFs. On Saturday, finance minister Nirmala Sitharaman said in the budget that it would provide another ₹10,000 crore to replenish the pot and continue to support these funds.

According to data from the Small Industries Development Bank of India (Sidbi), as on 13 September 2024, ₹10,913 crore worth of commitments have been made across 141 AIFs through this FoF. These AIFs have invested ₹19,992 crore in 1,120 startups.

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