The Assessing Officer has re-characterised my Category II AIF's interest, gains and processing fees as business income and denied the section 10(23FBA) exemption on the whole lot. What is the answer?
The Chennai Tribunal dismissed the Revenue's appeals. Income of a Category I or Category II AIF becomes business income only where the nature of the activities shows a systematic and organised commercial venture undertaken with the dominant intention of earning trading profits rather than making investments, tested by the ordinary badges — frequency and volume, holding period, intention at acquisition, treatment in the books, infrastructure and manner of execution — and here the re-characterisation had been made with no enquiry, no rejection of books, no show-cause notice on that head, and on the further erroneous footing that the assessee was a venture capital fund governed by section 10(23FB) and section 115U.
Decided by the ITAT (Shri Aby T. Varkey, Judicial Member and Ms. Padmavathy S, Accountant Member) on 2026-06-01, reported as ITA Nos. 3532/Chny/2025 and 3533/Chny/2025, Income Tax Appellate Tribunal, 'A' Bench, Chennai; assessment years 2020-21 and 2022-23; heard 7 May 2026, pronounced 1 June 2026. It bears on section 10(23FBA), section 10(23FBB), section 115UB, section 115UB(7), section 10(23FB), section 115U, section 143(3), section 250 of the Income Tax Act 1961, in Charitable Trusts & Exemption, Capital Gains Exemptions, Assessment & Scrutiny, Capital Gains and How Tax Law Is Read matters.
This is the Revenue-side counterpart every AIF adviser needs, because the only way to break a Category I or II pass-through is to move income into the head profits and gains of business or profession, and this order sets out both what the department must show and what it usually fails to show. Four points carry across. First, the Tribunal restated the statutory scheme in terms worth quoting to an Assessing Officer: income is first computed at AIF level under the normal provisions as if the AIF were a separate assessee, its character is retained, and income other than business income is exempt in the fund's hands under section 10(23FBA) but taxable directly in the investors' hands under section 115UB, while business income is taxed at AIF level and is exempt in the unit holders' hands under section 10(23FBB). Second, a receipt labelled a 'processing fee' does not become business income because of its label: here it was an upfront additional return on non-convertible debentures, part of the internal rate of return distributed to investors, and was held not to partake of the character of business income. Third, procedural failure matters — no specific show-cause notice proposing the head change, and no rejection of books, were both counted against the Revenue. Fourth, the Tribunal held that Schedule PTI in the return is to be filled by the investors receiving pass-through income and not by the investment fund itself, so an adverse inference from a blank Schedule PTI in the fund's return is factually wrong.
Binding on the AO and CIT(A) within the Tribunal's jurisdiction. Persuasive elsewhere.
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The assessee is a scheme of a Category II Alternative Investment Fund, a contributory trust under the Indian Trusts Act 1882 registered with SEBI under the SEBI (Alternative Investment Funds) Regulations 2012, whose objective is to invest predominantly in fully secured unlisted or listed securities of real estate builders and other entities. For assessment year 2020-21 it claimed as exempt under section 10(23FBA) interest income of Rs. 56,08,59,756, short-term capital gains of Rs. 3,62,52,992 and processing fees of Rs. 1,84,00,000, aggregating Rs. 61,55,12,750. The Assessing Officer held that all of it fell under the head profits and gains of business or profession rather than capital gains and other sources, that the assessee had furnished no details of the nature and amount of its investments, and that there were discrepancies in Schedule PTI of the return, and denied the exemption. The Commissioner (Appeals), National Faceless Appeal Centre, deleted the disallowance by order dated 24 September 2025, holding that the Assessing Officer had denied the exemption in a single paragraph with no analysis or reasoning, had wrongly applied section 10(23FB) and treated the assessee as a venture capital fund, and had given no opportunity on the ground of non-furnishing of investment details. The Revenue appealed for both years, its grounds being that the total income included a processing fee of Rs. 1,84,00,000 in the nature of business income, not exempt under section 10(23FBA), and that the assessee had clubbed it with interest under 'others' in Form 64D while showing business income as zero. Before the Tribunal the assessee explained that the interest arose on non-convertible debentures of only eleven companies with no borrowing (borrowing being prohibited), that the gains arose on units in mutual funds held as investments and not stock-in-trade, and that the so-called processing fee was an upfront additional return collected from investee companies for the inherent investment risk and taken into the internal rate of return distributed to investors.
Both Revenue appeals were dismissed. The action of the Assessing Officer in re-characterising the income as business income and thereby denying the exemption under section 10(23FBA) was held not tenable, and there was found to be no infirmity in the order of the Commissioner (Appeals) (paragraph 14). The Tribunal held that a receipt termed a 'processing fee' but intrinsically connected with the investments in non-convertible debentures, representing an additional return earned to compensate for investment risk and forming part of the yield used to compute the internal rate of return distributed to investors, does not partake of the character of business income (paragraph 13). The finding for assessment year 2020-21 was applied mutatis mutandis to assessment year 2022-23 (paragraph 15), and both appeals were dismissed (paragraph 16).
The Tribunal first set out the scheme of Category II AIF taxation: income is computed at AIF level under the normal provisions of the Act as if the AIF were a separate assessee, the character of the income is retained and allocated to unit holders in proportion to their shares, income other than profits and gains of business or profession is exempt in the AIF's hands under section 10(23FBA) but taxable directly in the investors' hands under section 115UB, and business income does not enjoy pass-through treatment but is taxed at AIF level and is exempt in the unit holders' hands under section 10(23FBB), with Form 64C to unit holders and Form 64D to the Department (paragraph 12). Against that framework it held that income of a Category II AIF is business income only where the nature of the activities demonstrates a systematic and organised commercial venture undertaken with the dominant intention of earning trading profits rather than making investments, the characterisation depending on the cumulative effect of the judicially recognised tests — frequency and volume of transactions, holding period, intention at acquisition, treatment in the books, deployment of infrastructure for trading operations, and the manner of execution and realisation. The re-characterisation here had been made without any proper enquiry or application of those tests, on presumptions, and without examining intention, frequency, treatment in the books, source of funds or the regulatory framework; the securities were consistently shown as investments and not stock-in-trade, and the assessee is a SEBI-registered Category II AIF prohibited from leverage or trading except within narrow limits (paragraph 13). On the processing fee, the Tribunal accepted that it was intrinsically connected with the investments in non-convertible debentures and formed part of the overall investment yield used for computing the internal rate of return distributable to investors, so the label did not change its character (paragraph 13). It then found force in the absence of any specific show-cause notice proposing reclassification, noted that the books had not been rejected and no material brought on record to show systematic trading, held that the Assessing Officer had proceeded on the erroneous assumption that the assessee was a venture capital fund governed by section 10(23FB) and section 115U which are inapplicable to a Category II AIF, and rejected the inference drawn from a blank Schedule PTI on the ground that Schedule PTI is to be filled by the investors receiving pass-through income and not by the investment fund itself (paragraph 14).
the action of the Assessing Officer in re-characterising the income as business income thereby denying the exemption under section 10(23FBA) is not tenable.
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Handle my notice → Ask a CA on WhatsAppThe Chennai Tribunal dismissed the Revenue's appeals. Income of a Category I or Category II AIF becomes business income only where the nature of the activities shows a systematic and organised commercial venture undertaken with the dominant intention of earning trading profits rather than making investments, tested by the ordinary badges — frequency and volume, holding period, intention at acquisition, treatment in the books, infrastructure and manner of execution — and here the re-characterisation had been made with no enquiry, no rejection of books, no show-cause notice on that head, and on the further erroneous footing that the assessee was a venture capital fund governed by section 10(23FB) and section 115U. This was decided by the ITAT (Shri Aby T. Varkey, Judicial Member and Ms. Padmavathy S, Accountant Member) and bears on section 10(23FBA), section 10(23FBB), section 115UB, section 115UB(7), section 10(23FB), section 115U, section 143(3), section 250 of the Income Tax Act 1961. It is reported as ITA Nos. 3532/Chny/2025 and 3533/Chny/2025, Income Tax Appellate Tribunal, 'A' Bench, Chennai; assessment years 2020-21 and 2022-23; heard 7 May 2026, pronounced 1 June 2026. This is the Revenue-side counterpart every AIF adviser needs, because the only way to break a Category I or II pass-through is to move income into the head profits and gains of business or profession, and this order sets out both what the department must show and what it usually fails to show. Four points carry across. First, the Tribunal restated the statutory scheme in terms worth quoting to an Assessing Officer: income is first computed at AIF level under the normal provisions as if the AIF were a separate assessee, its character is retained, and income other than business income is exempt in the fund's hands under section 10(23FBA) but taxable directly in the investors' hands under section 115UB, while business income is taxed at AIF level and is exempt in the unit holders' hands under section 10(23FBB). Second, a receipt labelled a 'processing fee' does not become business income because of its label: here it was an upfront additional return on non-convertible debentures, part of the internal rate of return distributed to investors, and was held not to partake of the character of business income. Third, procedural failure matters — no specific show-cause notice proposing the head change, and no rejection of books, were both counted against the Revenue. Fourth, the Tribunal held that Schedule PTI in the return is to be filled by the investors receiving pass-through income and not by the investment fund itself, so an adverse inference from a blank Schedule PTI in the fund's return is factually wrong. If it applies to you, the first step is this: Check first whether the assessment order has confused Category II AIF taxation with the venture capital regime; applying section 10(23FB) and section 115U to a Category II AIF is a jurisdictional error of the same kind the Tribunal found here.
The assessee is a scheme of a Category II Alternative Investment Fund, a contributory trust under the Indian Trusts Act 1882 registered with SEBI under the SEBI (Alternative Investment Funds) Regulations 2012, whose objective is to invest predominantly in fully secured unlisted or listed securities of real estate builders and other entities. For assessment year 2020-21 it claimed as exempt under section 10(23FBA) interest income of Rs. 56,08,59,756, short-term capital gains of Rs. 3,62,52,992 and processing fees of Rs. 1,84,00,000, aggregating Rs. 61,55,12,750. The Assessing Officer held that all of it fell under the head profits and gains of business or profession rather than capital gains and other sources, that the assessee had furnished no details of the nature and amount of its investments, and that there were discrepancies in Schedule PTI of the return, and denied the exemption. The Commissioner (Appeals), National Faceless Appeal Centre, deleted the disallowance by order dated 24 September 2025, holding that the Assessing Officer had denied the exemption in a single paragraph with no analysis or reasoning, had wrongly applied section 10(23FB) and treated the assessee as a venture capital fund, and had given no opportunity on the ground of non-furnishing of investment details. The Revenue appealed for both years, its grounds being that the total income included a processing fee of Rs. 1,84,00,000 in the nature of business income, not exempt under section 10(23FBA), and that the assessee had clubbed it with interest under 'others' in Form 64D while showing business income as zero. Before the Tribunal the assessee explained that the interest arose on non-convertible debentures of only eleven companies with no borrowing (borrowing being prohibited), that the gains arose on units in mutual funds held as investments and not stock-in-trade, and that the so-called processing fee was an upfront additional return collected from investee companies for the inherent investment risk and taken into the internal rate of return distributed to investors. The matter was decided on 2026-06-01 by the ITAT (Shri Aby T. Varkey, Judicial Member and Ms. Padmavathy S, Accountant Member). On those facts the ITAT held as follows. Both Revenue appeals were dismissed. The action of the Assessing Officer in re-characterising the income as business income and thereby denying the exemption under section 10(23FBA) was held not tenable, and there was found to be no infirmity in the order of the Commissioner (Appeals) (paragraph 14). The Tribunal held that a receipt termed a 'processing fee' but intrinsically connected with the investments in non-convertible debentures, representing an additional return earned to compensate for investment risk and forming part of the yield used to compute the internal rate of return distributed to investors, does not partake of the character of business income (paragraph 13). The finding for assessment year 2020-21 was applied mutatis mutandis to assessment year 2022-23 (paragraph 15), and both appeals were dismissed (paragraph 16).
The Tribunal first set out the scheme of Category II AIF taxation: income is computed at AIF level under the normal provisions of the Act as if the AIF were a separate assessee, the character of the income is retained and allocated to unit holders in proportion to their shares, income other than profits and gains of business or profession is exempt in the AIF's hands under section 10(23FBA) but taxable directly in the investors' hands under section 115UB, and business income does not enjoy pass-through treatment but is taxed at AIF level and is exempt in the unit holders' hands under section 10(23FBB), with Form 64C to unit holders and Form 64D to the Department (paragraph 12). Against that framework it held that income of a Category II AIF is business income only where the nature of the activities demonstrates a systematic and organised commercial venture undertaken with the dominant intention of earning trading profits rather than making investments, the characterisation depending on the cumulative effect of the judicially recognised tests — frequency and volume of transactions, holding period, intention at acquisition, treatment in the books, deployment of infrastructure for trading operations, and the manner of execution and realisation. The re-characterisation here had been made without any proper enquiry or application of those tests, on presumptions, and without examining intention, frequency, treatment in the books, source of funds or the regulatory framework; the securities were consistently shown as investments and not stock-in-trade, and the assessee is a SEBI-registered Category II AIF prohibited from leverage or trading except within narrow limits (paragraph 13). On the processing fee, the Tribunal accepted that it was intrinsically connected with the investments in non-convertible debentures and formed part of the overall investment yield used for computing the internal rate of return distributable to investors, so the label did not change its character (paragraph 13). It then found force in the absence of any specific show-cause notice proposing reclassification, noted that the books had not been rejected and no material brought on record to show systematic trading, held that the Assessing Officer had proceeded on the erroneous assumption that the assessee was a venture capital fund governed by section 10(23FB) and section 115U which are inapplicable to a Category II AIF, and rejected the inference drawn from a blank Schedule PTI on the ground that Schedule PTI is to be filled by the investors receiving pass-through income and not by the investment fund itself (paragraph 14). In the words reproduced by the source cited on this page: "the action of the Assessing Officer in re-characterising the income as business income thereby denying the exemption under section 10(23FBA) is not tenable."
It was decided by the ITAT on 2026-06-01 and is reported as ITA Nos. 3532/Chny/2025 and 3533/Chny/2025, Income Tax Appellate Tribunal, 'A' Bench, Chennai; assessment years 2020-21 and 2022-23; heard 7 May 2026, pronounced 1 June 2026. Binding on the AO and CIT(A) within the Tribunal's jurisdiction. Persuasive elsewhere. A Tribunal decision binds the assessing officer and the Commissioner (Appeals) within that Tribunal's jurisdiction, and is persuasive before other benches. It is not binding on a High Court, and a contrary co-ordinate bench decision will be argued against you, so check whether the point has been taken the other way before you build a reply around it. On section 10(23FBA), section 10(23FBB), section 115UB, section 115UB(7), section 10(23FB), section 115U, section 143(3), section 250, the practical question is whether the facts of your own notice match the facts of this case closely enough for the same rule to apply.
It helps the taxpayer. Both Revenue appeals were dismissed. The action of the Assessing Officer in re-characterising the income as business income and thereby denying the exemption under section 10(23FBA) was held not tenable, and there was found to be no infirmity in the order of the Commissioner (Appeals) (paragraph 14). The Tribunal held that a receipt termed a 'processing fee' but intrinsically connected with the investments in non-convertible debentures, representing an additional return earned to compensate for investment risk and forming part of the yield used to compute the internal rate of return distributed to investors, does not partake of the character of business income (paragraph 13). The finding for assessment year 2020-21 was applied mutatis mutandis to assessment year 2022-23 (paragraph 15), and both appeals were dismissed (paragraph 16). It arises in Charitable Trusts & Exemption, Capital Gains Exemptions, Assessment & Scrutiny, Capital Gains and How Tax Law Is Read matters, on section 10(23FBA), section 10(23FBB), section 115UB, section 115UB(7), section 10(23FB), section 115U, section 143(3), section 250 of the Income Tax Act 1961, and was decided by Shri Aby T. Varkey, Judicial Member and Ms. Padmavathy S, Accountant Member. Before relying on it, read the source linked on this page and check whether it has since been distinguished, overruled or overtaken by an amendment to the Income Tax Act. In practice the steps that follow from it are these. Demand a specific show-cause notice proposing the change of head. The absence of one, and the absence of any rejection of the books, were both material to the outcome. Put the badges of investment on the record: securities shown as investments and not stock-in-trade, a small number of investee companies, no borrowing or leverage (which the AIF Regulations and the placement memorandum prohibit for a Category II fund), and a stated investment objective. For a receipt described as a fee, show what it economically is — here, an upfront additional return on the NCDs, taken into the internal rate of return and distributed to investors — with the transaction documents behind it. Rebut any adverse inference from a blank Schedule PTI by pointing out that Schedule PTI is for the investors receiving pass-through income, not for the fund, and put the CBDT return-filing instructions on the record. Put the Form 64D filed under section 115UB(7) and the Form 64C generated for unit holders on the record, and show that the investors have already offered the income — the double taxation point was central to the Commissioner (Appeals)' reasoning that the Tribunal upheld. Where exemption has been allowed in earlier and later years on identical facts, say so; consistency was pressed here and not displaced.
Validity check could not be completed. Validity check could not be completed. The order was pronounced on 1 June 2026 and digitally signed on 4 June 2026; no search for an appeal against it, or for any later decision differing from it, was carried out this pass. The holding and the quoted sentence were obtained on three independent routes — the print view, which returned the full text of paragraphs 1 to 16 with the signature block, the plain document URL, which independently gave the paragraph count and the disposal, and a document fragment query for the operative sentence, which returned it in identical words. No source could be cited for that finding. Checking whether an authority still stands matters as much as knowing what it held: a decision may be overruled on one point and survive on another, or the provision it interprets may have been amended since. Read the source and the editor's note on this page before relying on it in a reply to an Assessing Officer or in an appeal.
The order runs to 16 numbered paragraphs, and paragraphs 1 to 16 were transcribed in one continuous block from the print view, which ends with the signatures of both Members and the dispatch note; the count and the disposal were independently obtained from the plain document URL. Read paragraph 5 with care: it reproduces the Commissioner (Appeals)' order at length, so the internally numbered passages 6.17 to 6.34 that appear inside it are the Commissioner (Appeals)' paragraphs and not the Tribunal's, and one of them wrongly records the assessee as 'a registered Category I Alternative Investment Fund' where the Tribunal's own finding throughout is Category II. Paragraphs 7 to 11 likewise reproduce the parties' submissions, including the Departmental Representative's written submissions, at length. Only paragraphs 12 to 16 are the Tribunal speaking. The order also records that the assessee relied on CIT v. India Advantage Fund-VII and CIT v. TVS Shriram Growth Fund for the proposition that income of a determinate trust is assessable in the beneficiaries' hands; the Tribunal did not decide on that footing and neither decision was read this pass. The words of sections 10(23FBA) and 10(23FBB) themselves were not read; what is said about them here is the Tribunal's own statement at paragraph 12. This library shows the verification state of every entry openly. This entry has not yet been read in full by a chartered accountant. The summary reflects the sources listed on this page. Read the source before you rely on it in a reply to an Assessing Officer or in an appeal before the Commissioner (Appeals) or the Income Tax Appellate Tribunal.
Both Revenue appeals were dismissed. The action of the Assessing Officer in re-characterising the income as business income and thereby denying the exemption under section 10(23FBA) was held not tenable, and there was found to be no infirmity in the order of the Commissioner (Appeals) (paragraph 14). The Tribunal held that a receipt termed a 'processing fee' but intrinsically connected with the investments in non-convertible debentures, representing an additional return earned to compensate for investment risk and forming part of the yield used to compute the internal rate of return distributed to investors, does not partake of the character of business income (paragraph 13). The finding for assessment year 2020-21 was applied mutatis mutandis to assessment year 2022-23 (paragraph 15), and both appeals were dismissed (paragraph 16).
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