Tax Relief for Category III AIFS: Delhi High Court's Ruling in Equity Intelligence v/s CBDT

[Sanskruti is a student at Gujarat National Law University.]

The taxation framework for alternative investment funds (AIFs) in India has presented significant challenges, particularly for Category III AIFs. These funds play a crucial role in facilitating private equity and venture capital (PE/VC) investments and are commonly structured as trusts. A key conflict has arisen between the regulatory requirements of the Securities and Exchange Board of India (SEBI) and the tax guidelines issued by the Central Board of Direct Taxes (CBDT). The Delhi High Court's judgment in Equity Intelligence AIF Trust v. Central Board of Direct Taxes and Another (2025) (Equity Intelligence AIF) addresses this conflict directly by invalidating CBDT Circular Number 13/2014’s (Circular No. 13/2014) application to the SEBI-registered Category III AIFs by invoking the doctrine of impossibility. This doctrine recognises that the law cannot require actions that are legally unfeasible.

In 2024, India's PE/VC sector attracted approximately USD 43 billion in investments. However, uncertainties in taxation have deterred potential investors and increased operational costs. The purpose of this article is to examine how the ruling resolves the longstanding regulatory conflict, evaluate its implications for the PE/VC ecosystem, and recommend legislative reforms to prevent similar issues in the future. By doing so, the article argues that while the judgment provides immediate relief, sustainable clarity requires statutory amendments to align tax and securities laws.

Historical and Regulatory Backdrop

Under Sections 161 to 164 of the Income Tax Act 1961 (IT Act), the trusts are categorised as either determinate or indeterminate for tax purposes. In a determinate trust, income is taxed according to the rates applicable to individual beneficiaries. In contrast, an indeterminate trust is subject to the maximum marginal rate (MMR), derived as 42.744% from the highest individual slab rate of 30% (on income exceeding INR 10 lakh), plus a 37% surcharge (applicable where total income exceeds INR 5 crore), and a 4% health and education cess on the aggregate tax and surcharge, inclusive of all components. The classification depends on whether the beneficiaries and their respective shares are clearly ascertainable at the time the trust is created.

Before 2014, CBDT Circular Number 281/1980 allowed flexibility in identifying beneficiaries beyond the deed. This approach changed with the issuance of Circular No. 13/2014. The new circular required that the names of beneficiaries and their shares be explicitly stated in the trust deed from the outset to qualify as a determinate trust.

This requirement conflicted with the SEBI (Alternative Investment Funds) Regulations 2012. Specifically, Regulations 3, 4, 6, and 7 prohibit AIFs from accepting investments or identifying investors until SEBI registration is granted. As a result, AIF trust deeds cannot include beneficiary details at the time of execution. Instead, such information is recorded later through contribution agreements and monitored via net asset value (NAV) statements and fund records.

Faced with this dilemma, many Category III AIFs adopted a cautious strategy. In Equity Intelligence AIF, the MMR was applied to all income, including capital gains, resulting in higher effective rates, such as 14.95 per cent (10 per cent base + surcharge/cess) on long-term capital gains (LTCG), rather than the standard 12.5 per cent. 

This approach increased costs and reduced returns, particularly for non-resident investors benefiting from Section 90 DTAA exemptions (which allow DTAA overrides), undermining FDI in India’s USD 43 billion (2024) PE/VC market.

Case Facts and Procedural Journey

The petitioner in this case, Equity Intelligence AIF Trust, is an open-ended Category III AIF registered with SEBI. The fund primarily invests in listed equity shares and operates as an irrevocable discretionary trust. Consistent with SEBI regulations, its original trust deed did not specify the names of beneficiaries or their shares. These details were instead documented in subsequent contribution agreements and NAV records.

The fund filed its income tax returns, treating itself as a determinate trust. However, tax authorities classified it as indeterminate based on Circular No. 13/2014, imposing the MMR. In 2018, the fund sought clarification from the Authority for Advance Rulings (AAR). Following the abolition of the AAR in 2021, the matter was transferred to the Board for Advance Rulings (BAR). In June 2024, the BAR upheld the authorities' position, relying on the circular's requirement for beneficiary details in the trust deed.

The fund then filed a writ petition under Article 226 before the Delhi High Court, challenging the circular as ultra vires Sections 160 and 164 of the IT Act. It argued that complying with the circular was impossible under SEBI rules and that beneficiary information was readily ascertainable through other fund documents. This seven-year procedural journey, from the 2018 AAR application, 2021 BAR transfer and June 2024 ruling, to the 29 July 2025 High Court judgment highlights the inherent delays in India's tax dispute resolution mechanisms for AIFs. Such protracted timelines not only amplify compliance costs but also perpetuate uncertainty in commercial decision-making, deterring timely investments in the PE/VC sector amid evolving regulatory overlaps between SEBI and tax authorities.

The Core Issue and the Court's Ruling

The central issue before the court was whether the omission of beneficiary names and shares from the trust deed rendered Category III AIFs indeterminate under Section 164 of the IT Act, even when such details were available in post-registration documents.

The Delhi High Court ruled in favour of the petitioner on 29 July 2025. It held that Circular No. 13/2014 could not apply to SEBI-registered AIFs, declaring it ultra vires in this context. The court applied the doctrine of impossibility, stating that the law cannot mandate actions that conflict with other statutory requirements. Key elements of the reasoning included:

• The need for harmonious interpretation between the IT Act and SEBI regulations, ensuring that tax compliance does not compel violations of securities laws.

• Reference to precedents such as Commissioner of Income Tax v. India Advantage Fund-VII (Karnataka High Court, 2017) and Commissioner of Income Tax v. TVS Shriram Growth Fund (Madras High Court, 2020) (TVS Shriram case), which confirmed that beneficiary shares could be determined through proportional allocations in fund records. The Revenue accepted both judgments and did not pursue further appeals on merits (SLP in TVS Shriram case dismissed, though on low tax effect).

• Recognition of the dynamic nature of AIFs, where fixed details in the initial deed are impractical for open-ended structures.

The court set aside the BAR's order and directed that the fund be assessed as a determinate trust, subject to normal tax rates. The ruling has retrospective effect from the assessment year 2018–19, invalidating past MMR impositions under the circular; this opens avenues for refund claims under Section 154 for excess tax paid (42.744% v/s investor-level rates), potentially unlocking significant recoveries across Category III AIFs.

This decision emphasises balance and practicality, differing from more rigid approaches in cases like JSW Steel v. Bhushan Power and Steel Limited (Supreme Court, 2025), where the SC upheld the IBC’s “clean slate” doctrine, prioritising strict compliance with Section 31(1) of IBC over commercial equities.

Implications for the PE/VC Ecosystem

The judgment offers immediate tax relief via standard rates (e.g. 12.5% on LTCG + surcharge), benefiting non-resident investors under DTAA and supporting 1,550 registered funds. Funds may recover part of the overpayments, potentially recovering substantial amounts. This development complements recent FDI reforms and promotes growth in key areas such as technology and infrastructure.

Nevertheless, potential challenges include appeals by the CBDT or new clarifications that could reintroduce uncertainty. The ruling's applicability is limited to the Delhi High Court's jurisdiction, which may result in inconsistencies across India. Comparatively, more flexible tax regimes in countries like Singapore highlight opportunities for India to enhance its competitiveness.

Critical Evaluation and Policy Recommendations

The ruling commendably resolves conflicts and enhances investor confidence through judicial intervention. However, it serves as a temporary solution rather than a comprehensive reform. Dependence on courts may lead to increased litigation, and the decision does not fully address potential misuse in less transparent fund structures.

To build on this progress, the following policy recommendations are proposed:

• The CBDT should withdraw or revise Circular No. 13/2014 and incorporate specific provisions for AIFs into the IT Act.

• Introduce a proportionality test for trust classification, evaluating the intent and materiality of any omissions, similar to approaches in insolvency law.

• Align tax policies with SEBI reforms, as outlined in the 2025 Union Budget's FDI initiatives, to create a unified regulatory framework.

These measures would reduce short-term risks and support the goal of achieving USD 50 billion in annual PE/VC investments.

Conclusion

The Delhi High Court’s decision in Equity Intelligence AIF effectively addresses a decade-long tax conundrum for Category III AIFs by applying the doctrine of impossibility. Retrospective from the assessment year 2018–19, it invalidates MMR under Circular No. 13/2014, enabling refunds of excess tax (42.744% v/s normal rates). It provides practical relief and fosters PE/VC growth. Nonetheless, to ensure enduring stability, legislative reforms are essential to harmonise tax and securities laws. This judgment represents a pivotal step toward a more robust and investor-friendly ecosystem in India.