DCIT v. Sundaram Alternative Opp Series High Yield Secured Debt Fund

Case snapshot

Sections / provisions: 10(23FBA)

Questions before the Court / Tribunal

• Category II AIF taxation; section 10(23FBA); processing fee character: The reported decision addresses pass-through/exemption treatment for a Category II AIF and the character of interest, capital gains and a processing-fee receipt connected with NCD investments. Full order details and the exact statutory pathway should be verified before indexing.

Material facts and background

under:“1. The order of the ld CIT(A) is contrary to law and facts and circumstances of 2. The ld CIT(A) erred in holding that the AO has failed to justify his finding that the assessee earned business income taxable u/s 10(23FBA) of the Act, thereby granting relief of exemption u/s 10(23FBA) of total income earned by the assessee to the tune of Rs.61,55, 12,750/-. 3. The Id CIT(A) failed to note that the total income earned by the assessee under different heads to the tune of Rs.61,55, 12,750/-, includes income earned in the nature of processing fee of Rs. 1,84,00,000/-, which is in the nature of business income not exempt as per section 10(23FBA) which grants exemption to any income of an investment fund (as defined under clause (a) of Explanation 1 of Sec. 115UB), other than the income chargeable under the head "Profits and gains of business or profession". 4. The ld CIT(A) ought to have noted that in order to avail the benefit of exemption for its entire income us 10(23FBA), including business income, the assessee has clubbed his business income in the nature of processing fee of Rs. 1,84,00,000/- with interest income in Form 64D under the head "others" and shown total income...

Secured Debt Fund, is set up as a scheme of Category II Alternative Investment Fund, a contributory trust under the provisions of the Indian Trust Act, 1882. The assessee is registered as a Category II Alternative Investment Fund with SEBI under the SEBI Alternative Investment Fund Regulations, 2012. The primary objective of the scheme is to invest predominantly in a

served on the assessee. The Assessing Officer held that the above incomes of the assessee are to be treated as income under the head “Profits and Gains from Business or Profession” and not under the head “Capital Gains” and other incomes as contended by the assessee. The Assessing Officer further held that the assessee has not provided any details about the nature and the amount of investments undertaken and in what capacity in various entities. The Assessing Officer also held that there are some discrepancies noticed in the ITR filed by the assessee in Schedule PTI. Therefore, the Assessing Officer held that the assessee cannot claim exemption under Section 10(23FBA) and disallowed the same. Aggrieved, the assessee filed further appeal before the CIT(A). 5.

Appellant / assessee submissions

Before the CIT(A), the assessee submitted that it is a Category II AIF

The ld. AR submitted that the assessee, being a Category II AIF, is not

The ld. AR presented the following table to explain the nature of income earned by the assessee:SR. INCOME (WITH DESCRIPTION OF TRANSACTION/INCOME NO. AMOUNT) 1. Interest on debt Since the investment objective is to invest in debt securities (Rs. securities, the return is in the form of interest on debt 56,08,59,756/-) securities. The Assessee made investment in NCDs of only 11 companies. Thus, there was no regular business. The strategy of the Assessee was to make investment in NCDs and generate interest income. Borrowings is one factor which shows carrying out of business. However, the Assessee is prohibited from borrowing funds to make investments (pg. 84). All investments are made from the investments made from investors’ funds. 2. Income from sale of Units in mutual funds are ‘capital asset’ u/s 2(14). units in mutual funds They were shown in the balance sheet as ‘Investments’ (Rs. 3,62,52,992/-) (pg. 194) and not as stock-in-trade. The investment was made in order to generate return for the investors. Hence, the gain generated on their sale is treated as ‘capital gains’ as opposed to business income. 3. Upfront additional This is nothing but in the nature of interest/...

The ld. AR, during the course of hearing, took the Bench through

The ld. AR submitted that the Assessee satisfied the definition of an

Revenue / respondent submissions

show-cause notice proposing to treat the income of the Assessee as business income and that the AO had also not rejected the books of account in the final assessment order. It was argued that the Departmental Representative could not travel beyond the findings recorded in the assessment order. The ld. AR also pointed out that Schedule PTI was required to be filled by the investors receiving pass-through income and not by the AIF itself, and therefore the observations of the AO in this regard were factually incorrect. It was further submitted that in earlier as well as subsequent assessment years, exemption under section 10(23FBA) had been consistently allowed to the Assessee and, therefore, the AO could not arbitrarily alter the characterisation of income without assigning reasons. The Assessee also emphasized that it had not undertaken derivative trading, futures or options transactions, and that its investment objective was merely to generate stable returns for investors. The ld. AR submitted that acceptance of the AO’s interpretation would render the beneficial provisions granting pass-through status to Category II AIFs otiose. The various factual and legal errors committed by...

The ld. DR supported the assessment order and contended that the

Assessee had failed to establish its eligibility for exemption under section 10(23FBA). It was argued that the nature of activities carried on by the Assessee, including earning processing fees and other investment-related returns, indicated a profit-oriented commercial activity liable to be assessed as business income. The ld. DR further submitted that the Assessee had not furnished adequate documentary evidence regarding the nature of investments and applicability of the exemption provisions. Reliance was also placed on the fact that Schedule PTI in the return of income was left blank, which according to the ld. DR created doubt regarding the Assessee’s claim of pass-through status. The ld. DR accordingly contended that the AO was justified in denying exemption and in treating the income of the Assessee under the head “Profits and Gains of Business or Profession.” 12.

Court / Tribunal analysis and reasoning

Taxation of IFSC Funds and its Investors Further, the CBDT has issued various circulars clarifying the position on income arising from the transfer of listed and unlisted shares and securities. Accordingly, the characterization of income as Business Income or Capital Gain needs to be assessed and determined based on the facts and circumstances of each case considering the principles set out in judicial precedents and various instructions and circulars issued by the CBDT. However, the Ld. AO has not made any such analysis and directly arrived at the conclusion that the appellant has earned Business income and brought the same to tax, brushing aside the submission of the appellant. 6.32 Investors in Category I and II AIF a) As mentioned above, Investors are liable to tax on income earned by AIF (other than Business Income. The tax liability is determined as if the investment by AlF was made directly by the investors and hence, the nature of income for the investors shall be the same as the income earned by AIF. Typically, an AIF could earn dividend income, interest income and capital gain on sale of shares and securities. 6.33 As the appellant has categorically explained that it is...

engaged in any business. The activity of the assessee mainly involves pooling of funds to make investments and, therefore, cannot be regarded as business.

show-cause notice proposing to treat the income of the Assessee as business income and that the AO had also not rejected the books of account in the final assessment order. It was argued that the Departmental Representative could not travel beyond the findings recorded in the assessment order. The ld. AR also pointed out that Schedule PTI was required to be filled by the investors receiving pass-through income and not by the AIF itself, and therefore the observations of the AO in this regard were factually incorrect. It was further submitted that in earlier as well as subsequent assessment years, exemption under section 10(23FBA) had been consistently allowed to the Assessee and, therefore, the AO could not arbitrarily alter the characterisation of income without assigning reasons. The Assessee also emphasized that it had not undertaken derivative trading, futures or options transactions, and that its investment objective was merely to generate stable returns for investors. The ld. AR submitted that acceptance of the AO’s interpretation would render the beneficial provisions granting pass-through status to Category II AIFs otiose. The various factual and legal errors committed by...

assessee as “business income”. The Assessing Officer while doing so has simply held that the income declared under the head capital gains, interest and processing fee are all to be classified under the head business income. It is relevant to note here that the Assessing Officer has treated the assessee as a Venture Capital fund which is an incorrect factual finding since the assessee is a SEBI registered Category II AIF. The income earned by a Category II AIF is classified as “Profits and Gains from Business or Profession” when the nature of the activities carried on by the fund demonstrates a systematic and organized commercial venture undertaken with the dominant intention of earning trading profits rather than making investments. The determination of such characterization depends upon the cumulative effect of various judicially recognised tests, including the frequency and volume of transactions, holding period of investments, intention at the time of acquisition, treatment of securities in the books of account, deployment of infrastructure for trading operations, and the manner in which the transactions are executed and realized. Where the AIF undertakes repetitive and...

regard submitted that the assessee has consistently shown the investments as “investments” in its books and not as stock-in-trade, and it is not in dispute that the assessee is a SEBI registered Category II AIF prohibited from undertaking leverage or trading activities except within the narrow limits permitted under the AIF Regulations. Further, the ld AR argued that the impugned income primarily arose from interest on debt securities, temporary parking of surplus funds in mutual funds, and additional return linked to investments, which by themselves do not automatically assume the character of business income. We further notice that the Assessing Officer's contention is also based on the income declared as processing fee is to be treated as business income. With regard to the said contention we notice as per the submissions that the processing fee received by the assessee was intrinsically connected with the investments made in NCDs and represented an additional return earned on such investments to compensate for the underlying investment risk. We also notice from the material on record that the said receipt formed part of the overall investment yield considered for computing the...

Operative decision and relief

1. अपीलाथ /Appellant 2. थ /Respondent 3. आयकर आयु /CIT, Chennai/Madurai/Coimbatore/Salem 4. िवभागीय ितिनिध/DR 5. गाड फाईल/GF Digitally signed by

Authorities and precedents appearing in the judgment

• Business Income vs Capital Gains
• Reliance was placed on the decisions in CIT v. India Advantage Fund-VII and
• CIT v. TVS Shriram Growth Fund in support of the proposition that income

This list is machine-assisted from the judgment text and is not a substitute for checking the full citation chain in the PDF.

Ratio and legal principle

The decision turns on Category II AIF taxation; section 10(23FBA); processing fee character. The operative result is classified as Operative order controls. Read the rule only with the statutory version, factual findings and precedent chain recorded in the full judgment.

Why this judgment matters

The case is relevant to taxpayers, advisers and litigators dealing with Category II AIF taxation; section 10(23FBA); processing fee character. Its practical value lies in the interaction between the statutory text, the evidentiary record and the procedural route followed in this case.

Practitioner action points

• Use the judgment as a fact-specific precedent: match the statutory version, assessment period, procedural stage and evidentiary record before relying on the result.
• Check whether a later High Court/Supreme Court order has affirmed, reversed, distinguished or rendered the decision academic.
• For litigation, attach the full judgment/order to the working paper and cite the paragraph/page supporting the proposition rather than relying on a headnote alone.

Full judgment and source trail

Read / download the authenticated official judgment PDF

Related Finin2min guidance