Category I and II AIFs get tax clarity in the Budget FY26

In a move to ease tax uncertainty amongst Alternative Investment Funds(AIFs), the government has now clarified income generated by Category I and II Alternative Investments Funds(AIFs) will be treated as capital gains. Till now, there was no specific provision on how such income would be treated but in the Budget for FY26, the government has expanded the definition of capital asset to include gains made by the AIFs under the income tax act.

Going forward, all the income generated by Category I and II AIFs shall be treated as capital gains taxed at 12.5%. If the same income is categorized as business income, it would be taxed at 30% for residents and upto 39% for non-residents.

“It is proposed to amend the Act to provide that any security held by investment funds referred to in Section 115UB which has invested in such security in accordance with the regulations made under the Securities and Exchange Board of India Act, 1992 would be treated as capital asset only so that any income arising from transfer of such security would be in the nature of capital gains.” Said the budget documents.

Category I and II AIFs are funds that invest in unlisted companies along with investments in debt instruments and infrastructure sector. Category III AIFs invest only in listed companies. Currently, Category I and II AIFs get pass-through status in terms of taxation, while Category III AIFs don’t get the same benefit. This amendment will take effect from April,1, 2026 and will apply from the assessment year 2026-27.