Section 194LBB – Income from Investment Fund Units: TDS for AIFs in India

Section 194LBB of the Income Tax Act mandates Tax Deducted at Source (TDS) on certain income distributed by an "investment fund" to its unit holders. This section specifically deals with the pass-through taxation status granted to Category I and Category II Alternative Investment Funds (AIFs).

Section 194LBB applies to any income, other than that proportion of income which is in the nature of "business income" of the investment fund, that is payable to a unit holder. This means primarily investment income such as interest, dividends, and capital gains (short-term or long-term) distributed by Category I and II AIFs are covered.

The "investment fund" itself (i.e., the Alternative Investment Fund) is responsible for deducting TDS when making payments of the specified income to its unit holders.

The TDS rates under Section 194LBB are:

• **10%** where the payee (unit holder) is a **resident**.
• **Rates in force** (generally higher, e.g., 30%, or as per applicable Double Taxation Avoidance Agreement - DTAA) where the payee is a **non-resident** (not being a company) or a foreign company.

It's important to note that if the income is not chargeable to tax under the Act for a non-resident, no deduction is to be made.

TDS is to be deducted at the time of credit of the income to the account of the payee (unit holder) or at the time of payment in cash, cheque, draft, or any other mode, whichever is earlier.

Unlike some other TDS sections, Section 194LBB generally does not specify monetary threshold limits for deducting TDS on the distributed income from investment funds. This means TDS applies regardless of the amount if the income is covered by the section.

An "investment fund" for Section 194LBB refers to a fund specified in Section 115UB of the Income Tax Act. This primarily includes Category I and Category II Alternative Investment Funds (AIFs) registered with SEBI. These funds are accorded a "pass-through" status for most income, meaning the income is taxed at the investor level, not at the fund level (except for business income).

Under the pass-through status (Section 115UB), income (other than business income) earned by Category I and II AIFs is not taxed at the fund level. Instead, it is treated as if the unit holders directly earned that income. The character of the income (e.g., capital gains, interest, dividend) remains the same in the hands of the unit holder as it was for the fund. Section 194LBB then facilitates the TDS on this income when distributed to the unit holders.

No. Section 194LBB specifically excludes the proportion of income that is of the same nature as "business income" referred to in Section 10(23FBB). Business income of Category I and II AIFs is generally taxed at the AIF level at the maximum marginal rate (MMR), not passed through to the unit holders. Therefore, TDS under 194LBB is not applicable on such business income distributed.

Yes, similar to other TDS provisions, the TDS deducted under Section 194LBB can be claimed as a credit by the unit holder when filing their Income Tax Return. If the unit holder's final tax liability is less than the TDS deducted, they may be eligible for a refund.

Income received from units of investment funds (AIFs) needs to be reported in your Income Tax Return, typically under the relevant heads of income (e.g., Capital Gains, Income from Other Sources) depending on the nature of income. There is also a specific Schedule PTI (Pass Through Income) in the ITR forms where details of such income and corresponding TDS from AIFs are to be furnished.

No, Category III AIFs generally do not have the pass-through status for all income. They are typically taxed at the fund level on various income streams (including capital gains and investment income). Therefore, Section 194LBB, which deals with TDS on pass-through income, does not apply to distributions from Category III AIFs in the same manner.

Failure by the investment fund to deduct or deposit TDS under Section 194LBB can lead to various consequences, including interest for delay in deduction/payment, penalties, and disallowance of expenditure (if applicable), as per the provisions of the Income Tax Act.

Section 194LBB states that for non-residents, no deduction shall be made in respect of any income that is not chargeable to tax under the provisions of the Act. If a non-resident unit holder can demonstrate that their income from the AIF is exempt from tax in India as per a Double Taxation Avoidance Agreement (DTAA), then TDS under this section would typically not apply. The unit holder would need to provide the necessary documentation (e.g., Tax Residency Certificate - TRC) to the fund.

Section 194LBB was inserted into the Income Tax Act with effect from June 1, 2015, as part of the broader framework for the taxation of Alternative Investment Funds and their distributions.