Taxation of Alternative Investment Funds (AIF) under the Income Tax Act 2025: Section 224 Explained

Under the Income-tax Act, 2025, a Category I or Category II Alternative Investment Fund (AIF) is taxed under section 224 on a pass-through basis. Income other than business income is not taxed in the fund (Schedule V, Table Sl. No. 1); it is taxed in the hands of the unit holder as if the unit holder had made the investment directly. Business income stays taxable in the fund, at the rate the Act sets for the fund's type. Tax is deducted at 10% on income paid to a resident unit holder, with no threshold.

This guide covers who counts as an "investment fund", how income and losses flow to unit holders, the deemed-credit rule, TDS, and the statements the fund must furnish. All figures come from the Act as amended by the Finance Act, 2026, and the Income-tax Rules, 2026. Examples use tax year 2026-27. Last reviewed on 10 November 2026.

What is an "investment fund" under section 224?

Section 224(10)(a) defines an investment fund as a fund set up in India as a trust, company, limited liability partnership or body corporate that holds a certificate of registration as a Category I or Category II AIF. It must be regulated under the SEBI (Alternative Investment Funds) Regulations, 2012, or the IFSCA (Fund Management) Regulations, 2022.

A Category III AIF is not an "investment fund" for section 224. A "unit" means the beneficial interest of an investor in the fund or a scheme of the fund, and includes shares and partnership interests (section 224(10)(c)).

How is an AIF taxed: at the fund or at the unit holder?

Both, depending on the kind of income.

Type of income	Taxed in the fund?	Taxed in the unit holder's hands?	Where in the Act
Any income other than "Profits and gains of business or profession" (capital gains, interest, dividend and so on)	No, excluded from the fund's total income	Yes, as if the unit holder had invested directly, in the same nature and proportion	Schedule V Sl. No. 1; section 224(1), (5)
Income under the head "Profits and gains of business or profession"	Yes	No, that proportion is excluded	Schedule V Sl. No. 2; section 224(6)

What rate is the fund itself taxed at?

Section 224(6) says the total income of the fund is charged at the rates in the Finance Act of the relevant year if the fund is a company or a firm. In every other case, such as a fund set up as a trust, it is charged at the maximum marginal rate. Because non-business income is excluded under Schedule V, this mostly matters for business income.

When is the income taxed in the unit holder's hands?

Section 224(7): income the fund earns in a tax year that it has not paid or credited to the unit holder is deemed credited on the last day of the tax year, in the proportion the unit holder would have received it. So the unit holder is taxed for the year the fund earned the income, not the year of cash distribution.

Section 224(8) prevents double counting. Income already included in the unit holder's total income because it accrued is not included again when the fund actually pays it out later.

Under section 224(5), income the fund pays or credits keeps its character. If the fund earned long-term capital gain, the unit holder receives long-term capital gain in the same proportion.

What happens to losses of the fund?

Section 224(2) applies when the fund's computation (ignoring Schedule V Sl. No. 1) ends in a loss under any head that cannot be fully set off against other heads in that year.

Kind of loss	Treatment	Section
Business loss	Carried forward and set off by the fund under Chapter VII. Not passed to the unit holder.	224(2)(a)
Other loss, on a unit held for 12 months or more	Passes to the unit holder under section 224(1)	224(1), 224(2)(b)
Other loss, on a unit held for less than 12 months	Ignored for the unit holder	224(2)(b)
Loss other than business loss accumulated in the fund as on 31 March 2019	Deemed the loss of the unit holder who held the unit on that date, carried forward under Chapter VII. Not available to the fund from 1 April 2019.	224(3), 224(4)

How is a Category III AIF taxed?

Section 224 does not apply to a Category III AIF, because the definition in section 224(10)(a) covers only Category I and II funds. Schedule V Sl. Nos. 1 and 2 therefore give it no pass-through, and the Act has no separate regime for it. Its income is assessed under the general provisions according to its legal form (trust, company, LLP and so on). Check the fund's structure and the applicable rates with a chartered accountant before filing.

Are securities held by an AIF capital assets?

Yes for Category I and II funds. Section 2(22)(b)(ii) treats securities held by an investment fund specified in section 224(10)(a), invested in line with the SEBI or IFSCA regulations, as a capital asset. Such a fund's gains on those securities are therefore capital gains, which pass to the unit holder under section 224.

Is there TDS on AIF income?

Yes. Section 393(1), Table Sl. No. 4(iii), requires an investment fund to deduct tax at 10%, with a nil threshold, on income payable to its unit holder, other than the proportion exempt under Schedule V Sl. No. 2 (the business-income proportion). Where the unit holder is a non-resident (not a company) or a foreign company, section 393(2), Table Sl. No. 8, applies and the rate is the rates in force.

Worked example 1: a resident investor's share of fund income

Assumptions: Category II AIF, tax year 2026-27. Meena holds 5% of the units, held throughout the year. The fund earns no business income. The fund earns Rs 1,20,00,000 of capital gains, Rs 50,00,000 of interest and Rs 30,00,000 of dividend, and pays Meena Rs 4,00,000 during the year.

Step	Working	Amount (Rs)
1. Meena's share of capital gains	5% x 1,20,00,000	6,00,000
2. Meena's share of interest	5% x 50,00,000	2,50,000
3. Meena's share of dividend	5% x 30,00,000	1,50,000
4. Income taxed with Meena for 2026-27	6,00,000 + 2,50,000 + 1,50,000	10,00,000
5. Deemed credited on 31 March 2027 but not yet paid	10,00,000 - 4,00,000	6,00,000
6. TDS at 10% on the Rs 4,00,000 paid	10% x 4,00,000	40,000

Meena reports Rs 10,00,000, split into capital gains, interest and dividend, in her return, and claims the Rs 40,000 TDS as credit. When the fund later pays the remaining Rs 6,00,000, she does not report it again (section 224(8)). This example does not compute her tax, which depends on her other income and the rates for each income type.

Worked example 2: a loss and the 12-month test

Assumptions: tax year 2026-27. After setting off within the fund, a non-business loss of Rs 5,00,000 remains. Ravi and Suresh each hold 10% of the units. Ravi bought his units 14 months before the year end. Suresh bought his 8 months before the year end.

Unit holder	Share of loss	Units held	Result
Ravi	10% x 5,00,000 = Rs 50,000	14 months (12 or more)	Rs 50,000 loss comes to Ravi under section 224(1)
Suresh	10% x 5,00,000 = Rs 50,000	8 months (under 12)	Rs 50,000 is ignored for Suresh under section 224(2)(b)

Ravi can set the loss off or carry it forward as Chapter VII allows. See our guide to set-off and carry-forward of losses and, for the filing condition, filing a return to carry forward losses.

Real-life example: an investor in a mixed fund

Anita, a salaried professional, commits money to a Category II AIF that buys unlisted shares and also runs a small trading book. At year end the fund reports capital gains and some trading profit. Anita's statement splits her share into both types. The capital gain part is taxed with her as capital gains. The trading part is taxed in the fund, so it is excluded from her income under Schedule V Sl. No. 2. She uses the fund's statement, not the bank credit, to fill her return.

Real-life example: a fund that sits on its income

A fund earns interest but distributes nothing this year. Vikram, a unit holder, receives no money. Under section 224(7), his share is still deemed credited on 31 March, so he reports it for that tax year. When the fund pays him next year, he does not report it again. Vikram keeps the statement to prove the amount was already taxed.

What statements must the fund furnish?

Section 224(9) requires the fund, and the person paying or crediting the income on its behalf, to furnish a statement giving the nature of income paid or credited during the year. Rule 145 sets the forms and dates.

Statement	To whom	Form	Due
Statement to the tax authority (verified by an accountant under section 515(3)(b))	Principal Commissioner or Commissioner of Income-tax where the fund's principal office is	Form 79	15 June after the tax year
Statement to the recipient	The person liable to tax on the income	Form 78	30 June after the tax year

The recipient's statement is generated and downloaded from the web portal specified by the Director General of Income-tax (Systems) and verified by the person paying or crediting the income (rule 145(3)). For income paid in tax year 2026-27, the dates are 15 June 2027 and 30 June 2027.

Section 263(1)(a) also lists an investment fund under section 224 among the persons who must furnish a return of income, even if its income is excluded under Schedule V.

Common mistakes

• Waiting for cash. Unit holders report income when it is deemed credited on 31 March, not when the fund pays (section 224(7)).
• Reporting the same income twice. Income already taxed on accrual is not taxed again on distribution (section 224(8)).
• Assuming every AIF qualifies. Section 224 covers Category I and II funds only (section 224(10)(a)).
• Claiming a pass-through loss on units held under 12 months. Such a loss is ignored for the unit holder (section 224(2)(b)).
• Treating business income as the unit holder's. That proportion is excluded for the unit holder and taxed in the fund.
• Missing the fund's statements. Forms 78 and 79 have fixed June dates under rule 145(2).

Quick reference

Item	Rule
Eligible funds	Category I and II AIF (section 224(10)(a))
Non-business income	Excluded in the fund, taxed with the unit holder
Business income	Taxed in the fund
Fund's tax rate	Finance Act rates for a company or firm; maximum marginal rate otherwise (section 224(6))
TDS, resident unit holder	10%, no threshold (section 393(1), Sl. No. 4(iii))
TDS, non-resident (not a company) or foreign company	Rates in force (section 393(2), Sl. No. 8)
Form 79 to authority	15 June
Form 78 to recipient	30 June

Where this is in the Act

• Section 224: tax on income of investment fund and its unit holders
• Schedule V, Table Sl. Nos. 1 and 2: income not included in total income
• Section 393(1), Table Sl. No. 4(iii), and section 393(2), Table Sl. No. 8: TDS
• Section 263(1)(a): return of income
• Rule 145: statements, Forms 78 and 79

CA firms that look after several fund investors can keep each client's unit holding, statements and TDS credits in one place with Finexo Practice Management Software for CAs, which tracks due dates and documents per client.

This article explains the Income-tax Act, 2025 (as amended by the Finance Act, 2026) and the Income-tax Rules, 2026. It is general information, not tax advice. Confirm the position for a specific case with a qualified chartered accountant.