Special Taxation Regime for Investment Funds [Sections 115UB & 10(23FB)] :

(i) Section 10(23FB) exempts any income of a Venture Capital Company (VCC) or Venture Capital Fund (VCF) from investment in a Venture Capital Undertaking (VCU). Further, as per section 115U, income accruing or arising or received by a person out of investment made in a VCC or VCF shall be taxable in the like manner as if the person had made direct investment in the VCU.

(ii) In effect, under sections 10(23FB) and 115U, a tax pass through status (i.e. income is taxable in the hands of investors instead of VCF/VCC) is available to such funds which satisfy the investment and other conditions as are provided in SEBI (Venture Capital Funds) Regulations, 1996. Further, these sections provide a “pass through status” only in respect of income which arises to the fund from investment in VCU, being a company which satisfies the conditions provided in SEBI (Venture Capital Fund) Regulations, 1996.

(iii) The SEBI (Alternative Investment Funds) Regulations, 2012 (AIF regulations) have replaced the SEBI (Venture Capital Fund) Regulations, 1996 (VCF regulations) from 21st May, 2012. Therefore, the AIF Regulations now regulate all privately pooled investment vehicles which collect funds from investors for investments in accordance with a predefined investment policy for the benefit of its investors AIF can be a fund established or incorporated in the form of a trust, company, LLP or body corporate. The AIF Regulations cover a much wider ambit of funds and categorize them into broadly three categories:

Category I AIF comprises of funds which invest in start-up or early stage ventures or social ventures or SMEs or infrastructure or other sectors or areas which the government or regulators consider as socially or economically desirable.

Category I AIF presently has 4 sub-categories, namely, venture capital funds, SME Funds, social venture funds and infrastructure funds. Investment norms have been prescribed for each of the sub-categories to ensure that the fund allocates substantial majority of its capital to the target focus. The stated intent of Category I AIF is to cover AIFs that are generally perceived to have positive spillover effects on economy and for which the SEBI/ Government/ other regulators might consider providing incentives or concessions.

Category II AIF is a residual category and covers AIFs for which no specific incentives or concessions are given by the Government/other regulators. Category II AIF will cover classic private equity funds and debt funds. Such funds do not undertake leverage or borrowing other than to meet day-to-day operational requirements.

Category III AIFs are AIFs which employ diverse or complex trading strategies and may employ leverage including through investment in listed or unlisted derivatives. Category III AIF will cover hedge funds or funds which trade with a view to make short term returns or such other funds which are open ended. As in the case of Category II AIFs, no specific incentives or concessions are given by the Government/other regulators.

(iv) The Finance Act, 2013 had granted “pass through status” to only the Venture Capital Fund, being a sub-category of Category I AIFs, with a corresponding direct tax charge on the investors. The benefit was available to only such AIFs which are established as a trust or a company. Further, the Income-tax Act, 1961 required compliance of three conditions by such AIFs, in order to be covered within the ambit of exemption under section 10(23FB).

(v) The tax implications on account of the amendment by the Finance Act, 2013 were as follows –

(1) VCCs/VCFs registered prior to 21st May 2012 under SEBI (VCF) Regulations, 1996 (VCF regulations), will not be affected by the amendment and will continue to be eligible for “pass through status” under section 10(23FB) read with section 115U.

(2) The impact on AIFs registered on or after 21st May, 2012 under AIF Regulations are summarized as follows :-

Category	Sub-categories	Tax status in the event AIF is registered on or after 21 May 2012
I	VCF, being trust & VCC	Would qualify as VCC/VCF under section 10(23FB) but, subject to compliance of three conditions viz., ► Shares of company/units of trust set up as an AIF are not listed on a recognized stock exchange. ► Has invested not less than 2/3rd of its investible funds in unlisted equity shares/equity linked

 

Category	Sub-categories	Tax status in the event AIF is registered on or after 21 May 2012
I		instruments of VCUs ► Has not invested in associate VCUs
I	SME Fund Social Venture Fund Infrastructure Fund	Will not qualify as VCC/VCF under section 10(23FB) and consequently will not be eligible for “pass through status” despite being identified as socially desirable having positive spillover effects on the economy and eligible for other concessions from Government/SEBI. Will be governed by normal provisions of taxation as applicable to relevant nature of entity.
II	Generally includes private equity and debt funds	Will not qualify as VCC/VCF under section 10(23FB)
III	Generally includes hedge funds

(vi) In order to rationalize the taxation of Category-I and Category-II AIFs (hereafter referred to as investment fund) the Finance Act, 2015 has now provided a special tax regime. Chapter XII-F comprising section 115U, containing the special provisions relating to tax on income received from venture capital companies and venture capital funds would not apply in respect of income of a previous year relevant to A.Y.2016-17, accruing or arising to, or received by, a person from investments made in a venture capital company or venture capital fund, being an investment fund.

Accordingly, the taxation of income of such investment fund and their investors shall be in accordance with the special tax regime under new Chapter XII -FB which is applicable to such funds irrespective of whether they are set up as a trust, company, or limited liability partnership etc.

Special Taxation Regime for Investment Funds [New Chapter XII-FB]

(1) Any income accruing or arising to, or received by, a person, being a unit holder of an investment fund, out of investments made in the investment fund shall be chargeable to income-tax in the same manner as if it were the income accruing or arising to, or received by, such person had the investments, made by the investment fund, been made directly by him. This is provided in new section 115UB(1).

(2) The Scheme provides for exemption under section 10(23FBA) of income, other than income from profits and gains of business, in the hands of investment fund. The income in the nature of profits and gains of business or profession shall be taxable in the hands of the investment fund.

(3) Income accruing or arising to, or received by, a unit holder of an investment fund, being that proportion of income which is of the same nature as income chargeable under the head “Profits and gains of business and profession” at investment fund level, shall be exempt under section 10(23FBB).

(4) With effect from 1st June, 2015, tax has to be deducted@10% on any income (other than the proportion of income which is of the same nature as income chargeable under the head “Profits and gains of business or profession” which is taxable at investment fund level) payable by the investment fund to a unit holder. Such tax has to be deducted at the time of credit of such income to the account of the payee or at the time of payment, whichever is earlier [Section 194LBB].

For this purpose, any such income credited to any account, whether called “suspense account” or by any other name, in the books of account of the person liable to pay such income, such crediting shall be deemed to be the credit of such income to the account of the payee, and the provisions of section 194LBB shall apply accordingly.

(5) If in any year there is a loss at the fund level, either current loss or the loss which remained to be set off, such loss shall not be allowed to be passed through to the investors but has to be carried over at fund level to be set off against income of the next year in accordance with the provisions of Chapter VI [Section 115UB(2)].

(6) The income paid or credited by the investment fund shall be deemed to be of the same nature and in the same proportion in the hands of the unit holder as if it had been received by, or had accrued or arisen to, the investment fund [Section 115UB(3)].

(7) As per section 115UB(4), the total income of the investment fund is chargeable to tax as follows:

Investment Fund	Rate of tax
A company or a firm	Rate or rates specified in the Finance Act of the relevant year (30% for A.Y.2016-17)
Other than a company or a firm	Maximum marginal rate

(8) Income paid by an investment fund to its unit holders would not be subject to dividend distribution tax under Chapter XII-D or tax on distributed income under Chapter XII-E [Section 115UB(5)].

(9) If the income accruing or arising to, or received by, an investment fund, during a previous year is not paid or credited to the unit -holders, it shall be deemed to have been credited to the account of the unit-holder on the last day of the previous year in the same proportion in which such person would have been entitled to receive the income had it been paid in the previous year [Section 115UB(6) ].

(10) The following table gives a summary of the above provisions

	Particulars	Investment Fund	Unit holder
(i)	Income under the head “Profits and gains of business or profession” of the Investment Fund	Taxable	Exempt
(ii)	Income, other than profits and gains of business or profession	Exempt. Tax to be deducted@10% on such income distributed to unit holders.	Taxable, as if he had directly made the investment.
(iii)	Any loss incurred by the investment fund	To be carried forward for set-off as per Chapter VI at the Fund level	Not passed on to investors
(iv)	Dividend distribution tax and tax on distributed income	Chapter XII-D and XII-E not to apply to income paid to unit holders.	–

(11) The person responsible for crediting or making payment of the income on behalf of an investment fund and the investment fund are required to furnish, within the prescribed time, to the person who is liable to tax in respect of such income and to the prescribed income-tax authority a statement in the prescribed form and verified in the prescribed manner. Such statement should give details of the nature of the income paid or credited during the previous year and such other relevant details as may be prescribed [Section 115UA(7)].

(12) TDS provisions would not be attracted in respect of the income received by the investment fund. This would be provided by issue of appropriate notification under section 197A(1F) subsequently.

(13) Every investment fund has to compulsorily file its return of income or loss under section 139(4F), if it is not required to do so under any other provision of section 139. The provisions of the Act would apply as if such return of income or loss were a return required to be furnished under section 139(1).

(14) Further, the existing pass through regime would continue to apply to VCF/VCC which had been registered under SEBI (VCF) Regulations, 1996. The other VCFs, being part of Category-I AIFs, shall be subject to the new pass through regime.

(15) It has been clarified that any income which has been included in the total income of the unit holder of an investment fund in a previous year, on account of it having accrued or arisen in the said previous year, would not be included in his total income in the previous year in which such income is actually paid to him by the investment fund.

(16) Meaning of certain terms:

	Term	Meaning
(a)	Investment fund	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 a Category II Alternative Investment Fund and is regulated under the Securities and Exchange Board of India (Alternative Investment Fund) Regulations, 2012, made under the Securities and Exchange Board of India Act, 1992;
(b)	Trust	A trust established under the Indian Trusts Act, 1882 or under any other law for the time being in force.
(c)	Unit	Beneficial interest of an investor in the investment fund or a scheme of the investment fund and shall include shares or partnership interests.

Illustration
The following are the particulars of income of three investment funds for P.Y.2015-16:

Particulars	A	B	C
	Rs in lakh
Business Income		2	(2)
Capital Gains	16	14	(6)
Income from other sources	4	4	8

Compute the total income of the investment funds and unit -holders for A.Y.2016-17, assuming that:

(i) each investment fund has 20 unit holders each having one unit; and

(ii) income from investment in the investment fund is the only income of the unitholder.

If Investment Fund C has the following income components for A.Y.2017-18, what would be the total income of the fund for that year?

Business Income Rs 2 lakh

Capital Gains Rs 9 lakh

Income from other source Rs 8 lakh

Answer
Computation of total income of the investment fund for A.Y.2016-17

Particulars	A	B	C
	Rs in lakh
Business Income	Nil	2,00,000	Nil
Total Income	Nil	2,00,000	Nil

Computation of total income of a unit holder of the following investment funds for A.Y.2016-17

Particulars	A	B	C
	Rs in lakh
Capital Gains	80,000	70,000	–
Income from other sources	20,000	20,000	30,000
Total Income	1,00,000	90,000	30,000

Notes:

(i) The total income of Investment Fund B would be chargeable to tax@30% if the fund is a company or firm and at the maximum marginal rate, in any other case.

(ii) In case of Investment Fund C, the business loss of Rs 2 lakh is set-off against income from other sources of ` 8 lakh. Loss of ` 6 lakh under the head capital gains cannot be set-off. The same has to be carried forward by the Investment Fund for set-off in the subsequent years.

(iii) For A.Y.2017-18, the brought forward capital loss of Rs 6 lakh can be set-off against capital gains of Rs 9 lakh. Business income of Rs 2 lakh would be taxable in the hands of the Investment Fund. Capital gains of RS 3 lakh (Rs 9 lakh – Rs 6 lakh) and Income from other sources of Rs 8 lakh would be taxable in the hands of the unit-holders. The total income of each unit holder for A.Y.2017-18 would be Rs 55,000, comprising of –

Capital gains = Rs 15,000 [i.e., Rs 3 lakh/20]
Income from other sources = Rs 40,000 [i.e., Rs 8 lakh / 20]