The Delhi High Court delivered a landmark judgment on July 29, 2025, bringing significant tax relief to Cat-III AIFs
Background
Cat-III AIFs include hedge funds, PIPE funds, and others employing complex trading, leveraging, and hedging strategies to generate short-term returns. Historically, these funds faced tax rates as high as 40% on gains due to an ambiguous 2014 Circular from the Central Board of Direct Taxes (CBDT).
Key Issues Addressed by the Court
- The 2014 CBDT circular required the naming or identification of all investors in the original trust deed. Failure to do so rendered the trust “indeterminate,” leading to taxation at the maximum marginal rate.
- Industry representatives argued this demand was impractical and conflicted with SEBI regulations, which do not require naming investors in the trust deed. Having to update the deed for every new investor would violate regulatory norms and create impossible administrative hurdles.
The Ruling
- The Delhi High Court quashed the adverse ruling by the Board of Advance Rulings (BAR), which applied the maximum marginal rate to a petitioner Cat-III AIF for not listing all beneficiaries at the inception.
- The Court observed that requiring all investors’ names in the original trust deed would make compliance impossible and held that legal or regulatory frameworks cannot demand that which is impossible to perform.
- Para 6 of the CBDT circular itself states that it is not operative in jurisdictions where High Courts have taken a contrary view, adding to the ambiguity.
Relief Granted
- The Delhi High Court “read down” the contested portions of CBDT Circular No.13/2014, making its stringent requirement for listing beneficiaries inoperative within its jurisdiction.
- The judgment clarified that the determination of beneficiary identities for AIFs should align with practical and regulatory realities and that once law is settled by a constitutional court, it binds tax authorities nationwide.
Broader Impacts
- Delhi now joins Karnataka and Tamil Nadu in offering clarity, Cat- III AIFs across three major jurisdictions benefit from reduced tax uncertainty and a lower tax burden, previously as low as 12.5% instead of the maximum marginal rate.
- Cat- III AIFs, the fastest-growing segment in India (with commitments of ₹2.3 trillion as of March 2025), now face less regulatory risk and enhanced ability to mobilize investments.
Practical Effect for AIFs and Investors
- Cat- III AIFs structured as determinate trusts with ascertainable beneficiaries (even if not named in the original deed) will not be mandatorily subject to the maximum marginal rate in Delhi.
- Pass-through status and determinate-trust treatment are more attainable, giving a boost to industry confidence and investor interest.
Funds and investors should review the order’s specifics before taking action
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