Investment-income character supports AIF pass-through exemption where receipts are not properly established as business income

Section 10(23FBA) read with Section 115UB provides fund-level exemption and pass-through taxation for non-business income of Category I and Category II Alternative Investment Funds. The decisive classification issue is whether receipts constitute profits and gains of business or profession. Interest on debt securities, short-term capital gains from mutual fund units, and processing fee linked to NCD investments may retain investment-income character where the fund is SEBI-registered, treats holdings as investments, operates without trading leverage, and lacks business-trading indicators. Reclassification requires examination of intention, transaction frequency and volume, accounting treatment, funding, infrastructure, and overall conduct. The analysis also notes that Schedule PTI is for investors, and that applying provisions governing different fund regimes is inappropriate.

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Issues: Whether a SEBI-registered Category II Alternative Investment Fund was entitled to exemption under Section 10(23FBA) of the Income-tax Act, 1961 on interest income, short-term capital gains and processing fee, or whether such receipts could be reclassified as business income so as to deny pass-through treatment under Section 115UB of the Income-tax Act, 1961.

Analysis: Section 10(23FBA) read with Section 115UB of the Income-tax Act, 1961 grants exemption at the fund level to income of a Category I or Category II investment fund other than income chargeable under the head profits and gains of business or profession, with corresponding taxation of such non-business income in the hands of unit holders. The decisive question was therefore whether the impugned receipts had the character of business income. The record showed that the assessee was a SEBI-registered Category II AIF functioning as an investment vehicle, was prohibited from undertaking leverage except within limited regulatory bounds, had shown its holdings as investments and not stock-in-trade, and had earned interest on debt securities, gains on sale of mutual fund units, and additional return linked to NCD investments described as processing fee. The settled tests for business income characterisation, including intention at acquisition, frequency and volume of transactions, treatment in books, source of funds, trading infrastructure and overall conduct, were not applied by the Assessing Officer. The recharacterisation was made on presumptions and on an incorrect factual premise treating the assessee as a venture capital fund and invoking provisions relevant to Section 10(23FB) and Section 115U instead of the regime under Section 10(23FBA) and Section 115UB. The processing fee was found to be intrinsically connected with the investment yield and merely being so labelled did not convert it into business income. The objection based on non-furnishing of Schedule PTI was also unsustainable because that schedule was required to be filled by investors receiving pass-through income and not by the investment fund itself. The absence of any proper enquiry, factual analysis, rejection of books, or specific notice proposing such reclassification further undermined the assessment.

Conclusion: The income earned by the assessee could not be reclassified as business income; the assessee was entitled to exemption under Section 10(23FBA) of the Income-tax Act, 1961 on the impugned receipts, and the issue was decided in favour of the assessee.

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