Section 224: tax on income of investment fund and its unit holders

Introduction

This provision governs pass-through treatment for qualifying investment funds and their unit holders. A unit holder’s income generally keeps the character it would have had on a direct investment.

Fund-level losses and unit-holder reporting are treated separately; not every loss passes through in the same way as income.

Key takeaways

Basic pass-through rule

Where a unit holder, out of investments made in an investment fund, receives any income or income accrues or arises to him, that income is chargeable to tax in the same manner as if he had made the investments directly - not as fund income.

Income paid or credited by the investment fund is deemed to be of the same nature and in the same proportion in the unit holder's hands as it was when received by, or accrued to, the fund during the tax year, subject to the special loss rules below.

Income accruing to the fund during a tax year, if not paid or credited to the unit holder, is deemed credited to the unit holder's account on the last day of the tax year, in the proportion he would have been entitled to receive it, subject to the special loss rules.

Income already included in a unit holder's total income on an accrual basis is not taxed again in the year it is actually paid to him.

Special treatment of losses at the fund level

Where the investment fund's net result under any head of income (computed without giving effect to Schedule V Table Sl. No. 1) is a loss for a tax year and cannot be wholly set off against income under another head:

• A loss arising under "Profits and gains of business or profession" is carried forward and set off by the investment fund itself under Chapter VII - it is not passed through to unit holders
• Any other loss is also not passed through to a unit holder if it relates to a unit that the unit holder has not held for at least twelve months
• Loss (other than business loss) accumulated at the fund level as on 31 March 2019 is deemed to be the loss of the unit holder who held the unit on that date, and may be carried forward by that unit holder under Chapter VII for the remaining permitted period, counted from the year the loss first arose
• Such deemed-transferred losses are no longer available to the investment fund itself on or after 1 April 2019

Taxation of the fund itself and reporting

The investment fund's total income is charged to tax at the rate(s) specified in the Finance Act of the relevant year if the fund is a company or a firm, or at the maximum marginal rate in any other case.

The person responsible for crediting or paying income on behalf of the investment fund, and the fund itself, must furnish a prescribed statement, within the prescribed time, to the taxable person and the prescribed income-tax authority, giving details of the income paid or credited during the tax year.

Key definitions

"Investment fund" means a fund established or incorporated in India as a trust, company, LLP or body corporate that holds a certificate of registration as a Category I or Category II Alternative Investment Fund, regulated under the SEBI (Alternative Investment Funds) Regulations, 2012 or the International Financial Services Centres Authority (Fund Management) Regulations, 2022.

"Unit" means the beneficial interest of an investor in the investment fund or a scheme of the fund, and includes shares or partnership interests.

Step-by-step flow for applying Section 224

1. 1

   Is the person a unit holder of an investment fund?

   Under Section 224(10)(a), an investment fund is a fund set up in India as a trust, company, LLP or body corporate, registered as a Category I or Category II Alternative Investment Fund and regulated under the SEBI (AIF) Regulations, 2012 or the IFSCA (Fund Management) Regulations, 2022.

   • No: Section 224 does not apply.
   • Yes: Go to the next step.
2. 2

   Tax the income as if the unit holder had made the fund's investments directly

   Section 224(1). Income paid or credited keeps the same nature and proportion as in the fund's hands (Section 224(5)), subject to Section 224(2).

3. 3

   Does the fund's computation show a loss under a head that is not wholly set off?

   • Business loss: It is carried forward and set off by the fund under Chapter VII, and is ignored for pass-through (Section 224(2)(a)).
   • Other loss: It is ignored for pass-through for a unit not held by the unit holder for at least twelve months (Section 224(2)(b)).
   • No loss: Go to the next step.
4. 4

   Was all the income paid or credited during the tax year?

   Under Section 224(7), unpaid income is deemed credited on the last day of the tax year in the proportion of entitlement. Under Section 224(8), it is not included again when actually paid.

5. 5

   Tax the fund's own total income and issue the statement

   A fund that is a company or firm is taxed at the rates in the Finance Act of the year; any other fund at the maximum marginal rate (Section 224(6)). The statement under Section 224(9) is in the prescribed form and time. Non-business losses held at fund level on 31 March 2019 are dealt with by Section 224(3) and (4).

Practical checklist

Frequently asked questions