In recent years, India has witnessed a rapid rise in Alternative Investment Funds (AIFs) as high-net-worth individuals and institutional investors seek diversified investment options. However, with increasing investment avenues comes the critical question of taxation. This is where Section 115UB of Income Tax Act comes into play.
The section is specifically designed to govern the taxation of income earned by Alternative Investment Funds & their unit holders. It brings clarity to how tax on income of investment fund and its unit holders should be handled, ensuring that the tax burden does not fall twice on the same income.
What is Section 115UB of Income Tax Act?
Section 115UB was introduced to establish a clear tax framework for Category I and Category II AIFs registered under SEBI. The idea is to treat AIFs as “pass-through entities” for most income categories.
This means that any income that the AIF earns & passes on to its investors is taxed in the hands of the investors themselves, not at the fund level. The fund simply acts as a channel. However, there are exceptions – particularly for business income, which is taxed at the AIF level."
In simple terms, Section 115UB deals with the taxation of income from investment in a specified investment fund, ensuring that investors are taxed directly on what they earn from the fund.
Objectives of Section 115UB
The primary objectives of this provision are:
- Avoid Double Taxation – Ensure that the same income is not taxed both at the fund & investor levels.
- Provide Clarity – Establish a transparent framework for the taxation of pass-through income.
- Encourage AIF Investments – By making tax treatment more predictable, investors are more likely to trust and invest in AIFs.
- Streamline Compliance – Simplify tax obligations for funds and their investors.
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Taxation Rules Under Section 115UB
- Pass-through for Certain Income
- Income other than business income (such as capital gains, dividends, or interest) is not taxed at the fund level.
- Instead, it is directly taxed in the hands of the unit holders.
- Business Income Exception
- If the fund earns income from business activities, it will be taxed at the fund level.
- Investors will receive post-tax income in such cases.
- Unit Holder Taxation
- Tax on income of investment fund and its unit holders is governed by the character of income.
- For example, if the fund earns long-term capital gains, the investor will also be taxed under long-term capital gains rules.
- Responsibility of AIFs
- AIFs are required to provide detailed statements to unit holders, showing the share of income that each investor is liable to pay tax on.
Example to Understand Section 115UB
Imagine an AIF earns ₹10 crore in a financial year. Out of this:
- ₹6 crore is from capital gains
- ₹3 crore is from interest income
- ₹1 crore is from business operations
Under Section 115UB:
- The ₹6 crore (capital gains) & ₹3 crore (interest) will pass through to investors, and they will pay taxes individually.
- The ₹1 crore (business income) will be taxed at the AIF level before distribution.
Thus, any income that the AIF earns and passes on to Sarah (or any other investor) will be taxed in her hands, while business income remains taxed at the fund’s end.
Importance of Section 115UB for Investors
For investors, this section provides multiple benefits:
- Transparency – You know exactly how your income will be taxed.
- Fair Taxation – The same income is not taxed twice.
- Compliance Support – AIFs provide income statements, making it easier to file returns.
- Encouragement for High-value Investments – Especially beneficial for those seeking long-term capital gains and diversification.
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Section 115UB and SEBI-registered AIFs
The section applies specifically to Category I and II AIFs under SEBI regulations. These typically include:
- Venture capital funds
- Private equity funds
- Infrastructure funds
- Debt funds
Category III AIFs, which are more like hedge funds, are excluded and taxed differently.
Challenges in Implementation
While Section 115UB simplifies taxation, it does come with its own challenges:
- Complex Reporting – AIFs must prepare detailed investor-wise statements.
- Different Tax Slabs for Investors – Since investors are taxed individually, compliance can get tricky.
- International Investors – Foreign investors in AIFs may face withholding tax complications.
- Dual-level Compliance – Both fund and investor must ensure accuracy in reporting.
Why Section 115UB Matters in India’s Tax System
India is pushing to become an attractive hub for global capital. By offering a clear & predictable tax regime for AIFs, Section 115UB plays a major role in drawing foreign and domestic investments."
It ensures that investors do not hesitate to explore AIFs due to tax confusion. In essence, the section provides a solid framework for the taxation of pass-through income that aligns with international best practices.
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Conclusion
Section 115UB of Income Tax Act is a landmark provision that ensures fairness in taxing income earned through Alternative Investment Funds. It provides a system where any income that the AIF earns & passes on to its investors is taxed directly in their hands, thereby avoiding double taxation.
By treating AIFs as pass-through vehicles, the section helps establish a framework for the taxation of pass-through income and clearly defines the tax on income of investment fund and its unit holders. While business income remains an exception, most other forms of income are passed through seamlessly.
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