NISM Series XIX-A · Unit 12 of 13 · about 5% of the paper
Taxation: India specific: NISM Series XIX-A notes and practice questions
How AIFs and their investors are taxed.
What to know in Unit 12
- Pass-through for Category I and II.
- Category III taxation.
- Character of income.
Key terms, examples and exam traps
Pass-through status
Category I and II AIFs enjoy pass-through status: income other than business income is taxed in the investors' hands, retaining its character.
Example. Capital gains of the fund are taxed in the investor's hands.
Exam trap. This statement is false: Category II AIFs pay tax on all income at the fund level.
Business income of AIF
Business income earned by a Category I or II AIF is taxed at the fund level and is not passed through.
Example. A fund's trading business profit is taxed at the fund.
Exam trap. This statement is false: All fund income is taxed in the investor's hands.
Category III taxation
Category III AIFs do not get pass-through status in the same way; income is generally taxed at the fund level as per the Act.
Example. A hedge fund's profits are taxed within the fund.
Exam trap. This statement is false: Category III AIFs are fully pass-through.
Character retained
Because of pass-through, gains retain their nature, such as long-term capital gains, when taxed in the investor's hands.
Example. A long-term gain in the fund remains long-term for the investor.
Exam trap. This statement is false: Gains lose their character after passing through.
TDS on distributions
Tax is deducted at source on income distributed to investors by pass-through AIFs at the rates prescribed, with credit available to the investor.
Example. The fund deducts tax at the time of distributing income.
Exam trap. This statement is false: AIFs never deduct TDS.
GST on fees
Management fees and certain charges to the fund may attract goods and services tax, affecting net returns.
Example. A fee invoice carries GST.
Exam trap. This statement is false: GST is not applicable on any fee.
Tax on carry
The manager's carried interest is taxed in its hands according to the nature of income, such as capital gains or business income.
Example. A manager's carry is reported in its own tax return.
Exam trap. This statement is false: Carry is taxed in the investors' hands.
Tax planning limits
Distributors should not provide tax advice beyond their remit; investors should consult a tax professional.
Example. A distributor suggests the client check with her tax adviser.
Exam trap. This statement is false: Distributors should give detailed tax opinions.
6 practice questions
Read each question and choose your answer before opening the free mock, which shows the correct answer and the reason.
Q1. Which term is described here? Business income earned by a Category I or II AIF is taxed at the fund level and is not passed through.
- Business income of AIF
- Ongoing manager review
- Investment manager
- Risk-adjusted performance
Q2. Which statement best describes “Category III taxation”?
- Managers track investee performance through reports, board meetings and key metrics, and intervene when needed.
- Changes in law or tax treatment can reduce net returns or alter the structure.
- Category III AIFs do not get pass-through status in the same way; income is generally taxed at the fund level as per the Act.
- The term clause states the fund's life and the conditions under which it can be extended, normally needing investor approval.
Q3. Which statement best describes “Character retained”?
- Because of pass-through, gains retain their nature, such as long-term capital gains, when taxed in the investor's hands.
- An AIF scheme must have a corpus of at least ₹20 crore (₹5 crore for an angel fund) before it begins investing.
- Venture capital funds early-stage, high-growth companies, accepting high failure rates for the chance of outsized returns.
- Legal DD reviews the offer documents, structure, regulatory standing and litigation to ensure investor protection.
Q4. Which term is described here? Distributors should not provide tax advice beyond their remit; investors should consult a tax professional.
- Tax planning limits
- Category II AIF
- Conflicts of interest
- Capital account statement
Q5. Which statement best describes “TDS on distributions”?
- Tax is deducted at source on income distributed to investors by pass-through AIFs at the rates prescribed, with credit available to the investor.
- Regulatory limits on single-investee exposure help to reduce concentration risk in Category I and II AIFs.
- Returns from alternatives depend heavily on manager skill, so dispersion between top and bottom managers is wide.
- An angel fund is a sub-category of Category I that pools money from angel investors to invest in early-stage start-ups, with smaller minimums.
Q6. Which statement best describes “Tax on carry”?
- AIFs cannot raise money through a public offer; they raise capital only by private placement.
- The manager studies the investee's business, financials, legal and tax position and management before investing.
- The manager's carried interest is taxed in its hands according to the nature of income, such as capital gains or business income.
- The management fee is a yearly percentage of commitments or invested capital charged to cover the manager's operating costs, regardless of performance.
Frequently asked questions
How much of NISM Series XIX-A comes from Unit 12?
Unit 12 (Taxation: India specific) usually carries about 5% of the questions. The whole exam has 100 questions and the pass mark is 60%.
What should I study in NISM Series XIX-A Unit 12?
Pass-through for Category I and II. Category III taxation. Character of income.
Are these NISM Series XIX-A practice questions free?
Yes. Take the full free mocks to see the correct answer and the reason for every question.
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