Major Relief for Category III AIFs as Delhi High Court Quashes CBDT Circular 13/2014

Issued on 28 July 2014, the 2014 CBDT Circular mandated that both the name and share of each beneficiary be expressly stated in the trust deed itself from inception. If not, the trust would be deemed “indeterminate” and taxable at MMR, regardless of whether the shares of beneficiaries were otherwise identifiable.

Consequently, even well-structured AIFs with clear investor records found themselves exposed to punitive tax treatment due to their inability to name beneficiaries before the AIF is registered under the SEBI Framework.

Taking a cautionary approach, most Category III AIFs began applying MMR to all their income (including capital gains) and computing tax at a flat rate (e.g., 14.95% on long-term capital gains), ignoring the investor-specific slab rates, exemptions, or loss set-offs. This approach, while conservative, was costly.

Equity Intelligence AIF Trust, a SEBI-registered Category III AIF, decided to challenge the status quo. Though its trust deed did not name individual investors, the fund consistently filed returns as a determinate trust, with investors’ shares identifiable from contribution agreements and NAV.

In 2018, the fund approached the Authority for Advance Rulings (AAR) seeking clarity on its tax treatment, specifically regarding whether it would be classified as a determinate or an indeterminate trust and the resulting tax implications due to such classification. When AAR was abolished in 2021, the case moved to the Board for Advance Rulings (BAR), which, in June 2024, ruled against the fund, relying squarely on the 2014 CBDT Circular and its requirement to name beneficiaries in the trust deed. This ruling was appealed before the Delhi High Court.

The Delhi High Court considered and concurred with the above reasoning and, in a decisive ruling, quashed the 2014 CBDT Circular in its application to SEBI-registered AIFs.

• Imposing a requirement that contradicts the SEBI Framework is legally untenable. The CBDT’s position effectively compelled AIFs to violate the SEBI Framework to comply with tax law, an outcome the Delhi High Court deemed unacceptable.
• A trust cannot be declared indeterminate merely because the names of the beneficiaries are not stated in the deed, so long as they are identifiable through legally recognised documentation like contribution agreements and NAV records.
• The BAR ruling of June 2024 was set aside, and the petitioner was directed to be assessed as a determinate trust, not subject to MMR under Section 164 of the IT Act.

This ruling potentially reshapes the tax landscape for the entire Category III fund industry. With the Delhi High Court declaring the 2014 CBDT Circular ultra vires, the long-standing basis for applying MMR to SEBI-registered AIFs has been dismantled.

As a result, the confusion created by the 2014 CBDT circular should now be resolved, both because (i) the doctrine of impossibility makes its core requirement legally untenable, and (ii) it should not be selectively applied only in jurisdictions lacking favourable High Court rulings, having been struck down by the Delhi High Court in its entirety.

This is especially significant for non-resident investors such as sovereign wealth funds and global universities, many of whom enjoy tax exemptions in their home countries. With the ruling in place, these investors could see improved post-tax returns on their investments in Indian funds. Investment managers now have strong judicial backing to stop applying conservative MMR taxation and instead assess funds as determinate trusts. The CBDT may be compelled to withdraw or amend the circular to align with court precedents. Past MMR tax payments could also be open to refund claims, potentially unlocking significant recoveries for funds and their investors.