What are the tax rules for Category 3 AIFs?

Tax rules for Category 3 AIFs, which are Alternative Investment Funds in India that include hedge funds and PIPE funds using leverage and complex trading, are less favorable than Category 1 and 2, as they do not enjoy full pass-through status. Category 3 AIFs are taxed at fund level at maximum marginal rate, currently around 42.74 percent including surcharge for income that is not capital gains, while capital gains are taxed at fund level at applicable rates, short-term capital gains at 15 percent for listed equities plus surcharge, long-term at 10 percent above 1 lakh, and business income from trading is taxed as business income. For investors, income received from Category 3 AIF after fund level tax is generally exempt in hands of investors to avoid double taxation, but fund does not get pass-through like Cat1 and Cat2 which are taxed in hands of investors. Category 3 AIFs cannot offset losses at investor level. For GIFT City AIFs, tax rules differ with exemptions like 10-year tax holiday for certain income and lower rates for NRIs. Category 3 AIFs must withhold TDS on payments. GST may apply on fees. Investors in Category 3 AIFs are typically high net worth individuals with minimum 1 crore investment. Tax rules are complex and evolving, SEBI and CBDT guidelines change, so investors should consult tax advisor. Unlike Category 1 and 2 which have pass-through under Section 115UB, Category 3 is taxed as per Section 115AD or business income, making it less tax efficient.