CHAPTER 16

TAXATION
 Taxation of Category I and II
Taxation depends on

 Residential status of taxpayer during a tax year

 Nature of Income earned

 Resident is liable to taxation in india on worldwide income with certain tax exemptions/deductions

 Non-resident is taxed on Indian-sourced income for income accrued, received or deemed to be accrued or
received in India
 Taxation arising to the AIF
The ITA has accorded tax pass through status to "Investment Funds " with respect to income other than
business income from investments.

Any fund established or incorporated in India in the form of a trust or a company or a limited liability
partnership or a body corporate which has been granted a certificate of registration as a category I or II
alternative investment fund and is regulated under Sebi regulations 2012.

Tax pass through enable zero tax liability on the income other than business income at investment fund level.
it will be taxable in the hands of beneficiary directly as per the respective tax status.

Any income other than business income earned by an investment fund is exempt in its hands and its
chargeable to income tax directly in the hands of its investors in the same manner as if it were the income
accruing or arising to, or received by, such investors had the investment been made directly by them.
 Taxation arising to the AIF
Taxation on business income.

a) The specified rate in Finance Act of the relevant year

b) The maximum marginal rate (MMR)

Taxation on business income is therefore exempt in the hands of the investor.

Any business loss at the fund level is not allowed to be passed through to its investors but is permitted to be
carried forward for set off against income of subsequent year.

Other than business loss shall be allowed to be passed through to the investors and allowed to be carried
forward and set off in the hands of investors of the AIF where the investors have held the unit of the AIF for at
least 12 months.
 Characterization of Income
Some principles laid down by various judicial precedents for characterization of income from sale of securities as
"business income" or "capital gains" are
1. Motive for the purchase of securities as perceived at the time of sale
2. The frequency of transactions in the period of holding of the securities
3. Treatment of the securities and profit or loss on their sale in the accounts of the assessee/ taxpayer
4. The source of funds out of which the securities were acquired - borrowed or owned
5. Existence of an object clause permitting trading in securities.
6. Acquisition of the securities - from primary market or secondary market.
7. The infrastructure employed for share transactions.
 Characterization of Income
Any single factor in isolation cannot be conclusive in determining the exact nature of transaction of investment in
securities all factors and principles need to be construed harmoniously.
CBDT has stated that in case of listed shares or other securities held for a period of more than 12 months, such can be
treated as capital gains and will not be disputed by Indian revenue authorities.
In case of transfer of unlisted shares, income arising from transfer of unlisted shares would be considered under the
head capital gains irrespective of the period of holding with a view to avoid dispute/ litigation. However, the above shall
not apply in the following cases;-
 The genuineness of transaction in the unlisted shares itself is questionable
 The transfer of unlisted shares is related to an issue pertaining to lifting of corporate veil
 The transfer of unlisted shares is made along with the control and management of underlying business.
Further it is clarified that the exception to transfer of unlisted shares made along with control and management of
underlying business could not apply to category I & II AIFs.
Taxation in the hands of resident
investors
The investment fund is exempted from tax for any income other than the business income and it is
charged directly in the hands of the unit holders as under : -
 The income shall we chargeable to tax in the hands of the unit holders in the same manner as if it
were the income accruing or arising to, or received by the unit holders had the investments made by
the fund being made directly by the unit holder.
 The income paid to the unit holders by the fund shall be deemed to be of the same nature and in the
same proportion in the hands of unit holders as it had been received by or is accrued/ arisen to the
fund
 The income accrued/ arisen to or received by the fund in any financial year which has not been
credited to the account of or distributed to the unit holders shall we deem to have been credited by
the fund to the account of the unit holders at the end of that financial year.
Taxation in the hands of resident
investors
The investment fund is exempted from tax for any income other than the business income and it is
charged directly in the hands of the unit holders as under : -

 Once the income is included in the total income of the unit holder in the previous year on
account of having been a crude or arisen in the said previous year will not be included in the
total income of such person in this year in which the sum is actually paid to the unit holder by
the fund.

 If the net computation of total income at the fund level is a loss (not being business losses)
such loss should be passed through to its unit holders for a set of or carry forward while
computing their income. However, such unit holders should continue to hold units in the fund
for a period of at least 12 months to be eligible for pass through of losses.
Taxation of different streams of
income
 Dividend income

 Interest income

 Sale or buyback of transfer of securities

Interest income

Taxable under the head "Income from other sources" at the tax rates (plus
applicable surcharge and health and education cess ) applicable to ordinary
income of resident investors
Dividend income
 The Indian company declaring dividend are not required to pay any dividend distribution tax.

 The dividend income is taxable in the hands of the shareholders at the applicable rates.
Deduction of interest expenditure is allowed which shall be capped at 20 % of the dividend
income.

 Any Indian company which receives dividend from another Indian company and the dividend is
distributed to its shareholders before the specified due date then the first Indian company can
claim a deduction of dividend received by it.
 Capital gains
Listed equity shares acquired and sold on a recognised Stock Exchange

 Share held for more than 12 months - long term capital asset otherwise short-term capital assets.

 No tax if the total long term capital gain from such shares do not exceed Rs. 1,25,000 if securities
transaction tax (STT) has been paid on both acquisition and transfer

 If the long-term capital gain exceeds Rs 1,25,000 the excess amount will be taxed at the rate of 12.5%
(plus applicable surcharge and health and education cess )without the benefit of indexation.

 Short-term capital gains on which STT is paid are subject to tax at 20 %(plus surcharge and cess)
 Capital gains
Unlisted equity shares sold through an offer for sale in an IPO or after listing on recognised Stock Exchange

 Unlisted shares sold through offer for sale in an IPO held for more than 24 months - long term capital asset
otherwise short-term capital assets.

 Unlisted shares sold after listing of shares on recognised Stock Exchange which were held for more than
12 months - long term capital assets.

 If the long-term capital gain exceeds Rs 1,25,000 the excess amount will be taxed at the rate of 12.5%
(plus applicable surcharge and health and education cess )without the benefit of indexation.

 Short-term capital gains on which STT is paid are subject to tax at 20 %(plus surcharge and cess).

 STT on acquisition is not applicable for unlisted equity shares.

 Capital gains
Acquisition and sale of unlisted shares

 Unlisted equity shares held for more than 24 months - long term capital asset otherwise short-term
capital assets.

 Long-term capital gain (complete amount ) will be taxed at the rate of 12.5% (plus applicable surcharge
and health and education cess )without the benefit of indexation.

 Short-term capital gains are subject to tax as per income tax slab.
 Capital gains
Listed debentures
 Listed debentures held for more than 12 months - long term capital asset otherwise short-term capital
assets.
 Long-term capital gain (complete amount ) will be taxed at the rate of 12.5% (plus applicable surcharge
and health and education cess )without the benefit of indexation.
 Short-term capital gains are subject to tax as per income tax slab of investors.
 Capital gains from Market linked debentures shall be deemed as short-term capital asset irrespective of
the period of holding (Finance Act 2023)
 Capital gains
Unlisted debentures

 Unlisted debentures held for more than 24 months - long term capital asset otherwise short-term capital
assets. BUT

 Capital gains from Market linked debentures shall be deemed as short-term capital asset irrespective of
the period of holding. (Finance Act 2023)

 Capital gains from Unlisted debentures on or after 23/07/2024 shall be deemed as short-term capital
asset irrespective of the period of holding. (Finance Act 2024)

 Short-term capital gains are subject to tax as per income tax slab of investors.
 Capital gains
Buyback of shares of a company on or before 30th September 2024

 Income for investor arising from this is exempt. However, the domestic company is liable to pay a
distribution tax at 20% applicable surcharge and cess the difference between the consideration paid for
the buyback and the amount received by the company at the time of issuing those shares.

 For foreign company, the shareholders are liable to pay tax on capital gain arising from this share
buyback.

Buyback of shares of a company on or after 30th September 2024

 Domestic company will no longer be required to pay distribution tax instead the income arising from the
buyback to the shareholder will be taxable in his own hands.
Capital gains
Conversion of preference shares into equity shares

 Conversion of preference shares into equity shares is not considered as a transfer; no capital
gain would arise in the hands of beneficiary on conversion.

 At the time of transfer of the converted equity shares the cost of acquisition of a convertible
preference shares would be deemed as the cost of acquisition of such equity shares

 Holding period prior to conversion shall be included in the period of holding of equity shares.
Capital gains
Share of profit from an LLP/ partnership firm

Exempted (No Tax) as already taxed at firm level

Capital gains
Transfer of partnership interest in LLP/ partnership firm

 Transfer of partnership which was held by the fund for more than 24 months - long term capital
asset otherwise short-term capital assets.

 Long-term capital gain will be taxed at the rate of 12.5% (plus applicable surcharge and health
and education cess )without the benefit of indexation.

 Short-term capital gains are subject to tax as per income tax slab.
Capital gains
Temporary investments - other incomes from mutual funds, fixed deposits etc.

Tax as per income tax slab of investor

Capital gains
Transfer of units of the fund

Depends on whether it is characterised as capital gains or business income, if capital gain then

 If unit was held by the fund for more than 12 months(listed) or 24 months(unlisted) - long term
capital asset otherwise short-term capital assets.

 Long-term capital gain on all such transfer of units will be taxed at the rate of 12.5% (plus
applicable surcharge and health and education cess )without the benefit of indexation.

 Short-term capital gains are subject to tax as per income tax slab of investors.

If business income, then the net income (after deduction of related expenses including cost of
units) should be taxable at the rates applicable to the resident investor.
 Taxability of income for non-
resident investors
Non-resident investor would be subject to taxation in India only if
 Indian - sourced income
 Income is received/ deemed to be received in India
 Any income has accrued/ deemed to have accrued in India in terms of the provisions of the ITA.
The taxation of non-resident investors is governed by the provisions of the ITA read with the provisions of the treaty
between India and the country of residence of such non-resident investor.
GAAR - general anti avoidance rule, MLI - multilateral instrument
To claim treaty benefits the non-resident investor is required to obtain a tax residency certificate–TRC issued by foreign
tax authority also form 10F.
Taxation in absence of treaty would be as per provisions of ITA
Interest income
 Taxable under the head " Income from other sources " on net basis, tax rates applicable to
ordinary income of non-resident investors.

 Certain specified interest income of a non-resident or foreign company is chargeable to tax on a

gross basis at the special rates.
Dividend income
 Indian company declaring dividend will not be required to pay any dividend distribution tax
declared to shareholders

 The dividend income of a non-resident investor is taxable on a gross basis without allowing any
deduction for any expenditure incurred to earn such income.
Capital gains
 Gains arising from the transfer of capital asset are chargeable to income tax under the head
capital gains.

 Difference between the full value of the consideration received or accrued on the transfer of
the capital asset and the cost of acquisition of such asset plus expenditure incurred wholly and
exclusively in connection to such transfer.
Capital gains
Type of instrument Period of holding Characterisation
listed securities/ unit of UTI/ unit of equity-oriented More than 12 months long term capital asset
fund/ zero coupon bonds
12 months or less short term capital asset
unlisted securities (including those offered through more than 24 months long term capital asset
offer for sale as part of an IPO) 2012 months or less short term capital asset
Market linked debentures transferred redeemed or
matured on or after 1st April 2023
Specified mutual funds (SMF) acquired on or after Irrespective of the
Short term capital asset
1st April 2023 holding period.
Unlisted bonds or unlisted debentures transferred,
redeemed or matured on or after 23 July 2024
Other Relevant Provisions of the
ITA
Deemed sale consideration on sale of unquoted shares

 Transfer of unquoted shares is done at a value lesser than fair market value then fair market
value will be considered as the full value of sale.

 FMV is determined as per the prescribed IT rules.

 FMV of unlisted equity shares would be based on the book value of assets and liabilities.

 FMV of all other shares and securities (other than equity shares) would be based on market
value of such shares and securities as certified by a merchant banker or a chartered
accountant.
Other Relevant Provisions of the
ITA
Shares subscribed at premium

 If the shares of Indian investing company are subscribed at premium, then the difference
between the consideration for subscription and FMV of such shares would be considered as
income handmade subject to tax in the hands of the investing company at normal tax rates

 This provision shall not apply from assessment year 25-26. any issue of shares on or after 1st
April 2024 will not be subject to the benchmark of Fair market value hence no tax shall be
charged even if the issue price exceeds the face value and fair market value.
Other Relevant Provisions of the
ITA
Deemed income on shares/ securities received without consideration or for inadequate
consideration

 If a person receives any property including securities at a price which is lower than its fair
market value, then the difference between the fair market value and actual consideration (if
greater than Rs. 50,000) shall be taxable in the hands of recipient of such property.

 Taxed as per the respective slab of income of investors.

Bonus stripping
 Any person who buys or requires any unit of a mutual fund or the unit trust of India within a period of
3 months prior to the record date can search person is allotted additional units and if such person
sells or transfer all or any of the original units within a period of 9 months after the record date while
continue to hold all or any of the additional units then any loss arising to him on account of such
purchase and sale of all or any of the units would be ignored for the purpose of computing income
chargeable to tax.

 The loss so ignored would be deemed to be the cost of acquisition of such additional units as are held
by him on the date of sale or transfer of original units.

 Effective 1st April 2022 the bonus stripping provisions cover all securities and units including units of
a business trust units of REIT / InvIT and beneficial interest of an investor in an AIF
Dividend stripping
 same as bonus stripping except Loss does not exceed the amount of dividend or income received or
receivable
Expenditure incurred in relation to
income not includible in total income

If any income of the investor does not form the part of the total income or is exempt under
the provisions of the IT a then any expenditure is also not allowed
 Minimum alternate tax(MAT)/
Alternate minimum tax(AMT)
 MAT on corporates, AMT on non-corporates
 If MAT/AMT is held to be applicable to the unit holders, then income receivable from their investment in the fund
should also be included.
 Exceptions for MAT - insurance companies n companies under section 115BAA or section 115BAB
 MAT – 15% (plus surcharge and cess), AMT – 18.5% (plus surcharge and cess)
 The MAT/AMT credit is available to be carry forward for a period of 15 years.
 MAT/AMT provision does not apply to foreign companies if
Assesse is a resident of a country with which India has a treaty and the assesse does not have a PE in India
Assesse is a resident of a country with which India does not have a treaty hand is not required to seek registration
under the Indian corporate law
Withholding of tax by an AIF
 Resident investor - 10% on all income other than businessman

 non-resident investor - 20% if income distributed is in the nature of dividend, for all other type
of income the tax shall be deductible at the rates in force as specified in applicable double tax
avoidance agreement.

 investors are entitled to claim credit of taxes so withheld by the investment fund in their
respective returns of income which are to be filed under the ITA

 The payer of the income to the investment fund is not required to withhold any taxes while
paying or crediting income (other than business income). Therefore, the investment fund would
not suffer any withholding of taxes from its non-business income.
Reporting Compliances for AIF
under ITA
 It is mandatory for the investment fund to file its return of income

 Income paid or fun to which unit holder in a given financial year shall be furnished by the person
responsible for creating online payment of the income on behalf of an investment fund to the unit
holder by 30th day of June of the following financial year.

 Form 64 C

Electronic form 64 D should be submitted to the principal commissioner of income tax by 15th
June of the following financial year under digital signature duly verified by practicing chartered
accountant
 Taxation of category III AIF
 It does not enjoy tax pass through status at the fund level

 Tax regime depends on legal structure of the entity - revocable trust or irrevocable trust

 Taxation depends on
a) nature of transfer / contribution by investor( revocable or irrevocable)
b) whether beneficiaries and their respective interests in the fund are identified/ determined upfront or not
(determinate or indeterminate trust)
c) nature of activity undertaken by the fund( whether any business activities undertaken or not)
Revocable v. irrevocable transfer
 Transfer of an asset is considered revocable when the transferred document contains a
provision for
a) Retransfer, directly or indirectly, of the whole or any part of the income from the asset to the transferor
b) gives a right to the transferor to reassume power, directly or indirectly, over the whole or any part of the
income or asset.

 If trust is revocable in nature, then the beneficiaries will be liable to tax on the income
attributable to such revocable contributions.

 Typically, category III AIFs are not structured as trust having revocable transfer
 Irrevocable Determinate Trust
 Determinate if
a) Beneficiaries are identifiable on the date of indenture of trust (in trust deed)
b) Individual share of income of each beneficiary is ascertainable as on date of the indenture of trust.

 Considered as determinant if the instrument of trust specifies the categories of beneficiary in the trust and
prescribes a methodology for the determination of share of each beneficiary
 If Determinate irrevocable trust, then income is taxed in the hands of trustee as it would be levied on the
beneficiaries.
 Once the income is taxed at the hands of trustee, no further tax implications on subsequent distribution of the said
income subject to MAT implications for corporates.
 Tax authorities has the right to assess the income directly in the hands of beneficiary under section 166 of the ITA,
if not already assessed in the hands of trustee. Tax paid by trustee will be available as credit against the total tax
liability.
IRREVOCABLE INDETERMINATE
TRUST
 TRUST which does not meet the criteria of determinate trust

 Judicial precedent available for LTA capital gain tax at 12.5 % and STA capital taxed at 20 %

 CBDT vide circular dated 28 July 2014 as clarified in a situation where the fund is treated as
indeterminate trust then the entire income is liable to be taxed at the MMR in the hands of the
trustee of such fund in their capacity of representative assessee.
 Taxation of category III
determinate irrevocable trust
 Profits or gains from business and profession – MMR

 Unit holder income will come primarily from

a) Interest Income
b) Dividend Income
c) Gains on transfer of listen & unlisted securities
d) gains arising from transaction and derivatives such as futures and options

 Most of the category III AIF take a practical approach and discharge taxes at a fund level considering
maximum rate applicable to an income stream using PAN of the fund
Interest Income received by Resident Investors Non-Resident (subject to
beneficial tax rate under relevant
tax treaty)
Companies (turnover more than 40 crore) 34.944 % 38.22 %
Companies (turnover less than 40 crore) 29.12 % 38.22 %
Companies under 115BAA 25.168 % 38.22 %
Companies under 115BAB 17.16 % 38.22 %
Firms/LLP 34.994 %
Individuals/HUF/AOP/BOI 42.744%

 NRI taxed @ 28.496% on gross basis, subject to beneficial tax rate under the relevant tax treaty.
DIVIDEND INCOME
 Company paying dividend would deduct tax on the pan of the fund at 10% in case of payment to
resident investor at 20% in case of risk payment to non-resident investor.
Dividend Income received by Resident Investors Non-Resident (subject to
beneficial tax rate under relevant
tax treaty)
Companies (turnover more than 40 crore) 34.944 % 21.84 %
Companies (turnover less than 40 crore) 29.12 % 21.84 %
Companies under 115BAA 25.168 %
Companies under 115BAB 17.16 %
Firms/LLP 34.944 % 23.296 %
Individuals/HUF/AOP/BOI 35.88% 23.92 %
Mutual Fund INCOME
 The mutual fund would deduct tax on the pan of the fund at 10% in case of payment to resident
investor at 20% in case of risk payment to non-resident investor.
Mutual Fund Income received by Resident Investors Non-Resident (subject to
beneficial tax rate under relevant
tax treaty)
Companies (turnover more than 40 crore) 34.944 % 21.84 %
Companies (turnover less than 40 crore) 29.12 % 21.84 %
Companies under 115BAA 25.168 %
Companies under 115BAB 17.16 %
Firms/LLP 34.944 % 23.296 %
Individuals/HUF/AOP/BOI 42.74 % 28.496 %
CAPITAL GAINS

Refer Table on Page No. 472.

DERIVATIVE CONTRACTS –
FUTURE & OPTIONS
 Any gains from these transactions shall be treated as profits and gains from business and
professions - taxed at MMR that is 42.744 %
Deemed income from shares and securities
received without consideration or inadequate
consideration
 The difference between the FMV and the consideration if more than 50,000 then it is taxable in
the hands of acquirer as income from other sources.

Particulars effective tax rate for effective tax rate for non-
resident investors resident investors
In case of companies 34.944% 38.22%
Individuals/HUF/AOP/BOI 42.744% 42.744%
Other investors 34.944% 34.944%
Set off and carry forward of loss
 Intra head adjustment of loss
◦ If in any year the taxpayer has incurred loss from any source under a
particular head of income, then such person is allowed to adjust such loss
against income from any other source falling under the same head of
income subject to the following restrictions
 Long term capital loss cannot be set off against any income other than long term capital gain
 Short term capital loss can be set off against long term or short-term capital gain
 Speculative business losses cannot be set off against non-speculative business gains
Set off and carry forward of loss
 Inter head adjustment of loss
◦ If in any year the taxpayer has incurred loss under one head of income and
is having income under other head of income, then such person can adjust
the loss from one head against the income from the other head of income
subject to following restrictions
 Before making entire head adjustment the taxpayer must first make intra head adjustment
 Loss under the head capital gains cannot be set off against income under any other heads of
income
 Loss from business and profession cannot be set off against income chargeable to tax under the
head salaries
Business loss other than loss
from speculative business
 loss of any business/ profession other than speculative business cannot be fully adjusted in the
year in which it is incurred then the unadjusted loss can be carried forward for making adjustment
in the next year

 Such laws can be adjusted only against income charged to tax under the head profit and gains
of business or profession

 such loss can be carried forward for eight years immediately succeeding the year in which the
loss is incurred

 Speculative business loss can only be carried forward for four years immediately succeeding the
year in which the loss is incurred
Carry forward and set off of
capital loss
 If loss under the head capital loss cannot be fully adjusted in the year in which it is incurred then
the unadjusted loss can be carried forward for making adjustment in the next year

 such loss can be carried forward for eight years immediately succeeding the year in which the
loss is incurred.