Overview: Some Category III Alternative Investment Funds (AIFs) in GIFT City’s International Financial Services Centre (IFSC) have reportedly received surcharge-related tax demands for Assessment Year 2024-25 and AY 2025-26. The issue concerns surcharge relief introduced by the Finance Act, 2023. Eligible specified funds may challenge demands that conflict with the applicable law, but their eligibility, income classification and tax computations must be checked before taking action.
Some Category III Alternative Investment Funds (AIFs) in GIFT City have reportedly received surcharge-related tax demands on dividend and interest income for Assessment Year 2024-25 and AY 2025-26, according to a Business Standard report. The notices have raised concerns over the implementation of surcharge relief introduced by the Finance Act, 2023.
The issue puts the tax treatment of qualifying specified funds under scrutiny. Fund managers need to verify their eligibility, investor structure and tax computations before deciding whether a demand warrants rectification or an appeal.
GIFT City AIFs Receive Tax Notices
Some Category III AIFs in GIFT City, reportedly, received tax notices seeking surcharge on dividend and interest income for AY 2024-25 and AY 2025-26.
Tax professionals, according to the report, suggested that some notices may have resulted from automated processing errors or standard queries that did not account for the funds’ particular circumstances. The report does not establish that every demand is incorrect.
The issue centres on Section 115AD of the Income-tax Act, 1961. The provision prescribes special tax treatment for securities income earned by specified funds, subject to statutory conditions.
Fund managers should therefore compare each demand with the filed return, tax computation and supporting records before deciding whether to seek rectification or pursue an appeal.
The Surcharge Relief
The Taxation and Other Laws (Relaxation and Amendment of Certain Provisions) Act, 2020, introduced a 10% tax rate under Section 115AD(1)(a) for qualifying specified-fund income from securities. A lower 5% rate applies to interest income covered by Section 194LD, subject to the relevant conditions.
The Finance Act, 2023, introduced surcharge relief from AY 2024-25 for qualifying specified-fund income under Section 115AD(1)(a), other than capital gains. The Income Tax Department’s published guidance also provides for zero health and education cess on the tax payable on qualifying securities income received by a specified fund.
For AY 2024-25 and AY 2025-26, the applicable treatment generally means a 10% tax rate on qualifying securities income, without surcharge or health and education cess on the tax attributable to that income. The specific treatment of interest covered by Section 194LD must be considered separately.
These rates should not be treated as applicable to every income stream or future tax year. Section 115AD was amended with effect from 1 April, 2026, including a change to the rate applicable to specified-fund securities income.
Eligibility is the key condition. Under the specified-fund definition in Section 10(4D), the fund must satisfy the applicable regulatory and IFSC-location requirements. The definition also requires that all units, other than the ones held by a sponsor or manager, are held by non-residents. Section 115AD(1A) further limits the provision’s application to income attributable to units held by qualifying non-residents, calculated in the prescribed manner.
A GIFT City address alone does not establish eligibility. The fund must meet the relevant statutory conditions, and the income must fall within the scope of the relief.
The Income-tax Act, 2025, came into force on 1st April, 2026. However, Section 536 contains repeal-and-savings provisions governing the transition from the Income-tax Act, 1961. The relevant provisions of the 1961 Act continue to apply to proceedings concerning earlier tax years in accordance with those savings provisions. The reported demands must therefore be assessed under the law applicable to the relevant assessment years.
Tax Treatment: What Fund Managers Should Check
The following table summarises the principal distinctions relevant to fund managers. The actual treatment depends on the fund’s structure, income and applicable statutory conditions.
| Income or fund category | General tax treatment | Key consideration |
|---|---|---|
| Category I and II AIFs | Eligible income generally passes through to unit holders under Section 115UB. | Business income is generally taxed at fund level under the applicable provisions. |
| Category III specified funds | Qualifying securities income is taxed under Section 115AD. | For the assessment years in the reported dispute, the applicable rate is generally 10%, subject to specific exceptions and eligibility conditions. |
| Capital gains | Taxed under the applicable capital-gains provisions and rates. | Do not extend the surcharge relief for qualifying non-capital-gains income to capital gains automatically. |
| Income covered by Section 10(4D) | Certain qualifying income or transactions may be exempt. | The specific exemption, fund status, transaction and statutory conditions must be verified. |
Section 10(4D) and Section 115AD serve different purposes. Section 10(4D) provides specified exemptions, while Section 115AD prescribes tax treatment for qualifying securities income and certain capital gains. Fund managers should identify the precise provision applicable to each receipt rather than assume that all income of a specified fund is exempt.
Essential Compliance Checks for AIF Managers
Fund managers and Fund Management Entities (FMEs) should maintain clear records of the fund’s regulatory status, investor structure, tax position and reporting obligations.
1. Verify specified-fund eligibility
Confirm the fund’s Category III AIF registration, location in an IFSC and unit-holding structure. Review the relevant conditions under Sections 10(4D) and 115AD, including the treatment of income attributable to qualifying non-resident unit holdings.
2. Reconcile the tax return and demand
Compare the filed return, income computation, tax payments, tax deducted at source (TDS) records and demand notice. Identify whether surcharge or cess has been applied to income that qualifies for relief.
The applicable return form should be selected according to the fund’s legal constitution and statutory filing obligation. Section 139(4F), which concerns investment funds under Section 115UB, should not automatically be treated as the filing basis for Category III specified funds.
3. Review regulatory reporting
Check the FME’s registration, scheme conditions, investor disclosures, valuation records, audit requirements and applicable reporting obligations under the International Financial Services Centres Authority (IFSCA) framework.
4. Maintain supporting documents
Keep registration records, unit-holding details, income classifications, tax computations and correspondence with the tax department in an organised file. These records can support a rectification request or appeal if the demand appears inconsistent with the law.
Remedies for an Incorrect Surcharge Demand
The appropriate remedy depends on the order received, the reason for the demand and the evidence available.
1. Seek rectification under Section 154
Section 154 allows an income-tax authority to rectify a mistake apparent from the record in an eligible order or intimation. Where the demand arises from an apparent processing error, the fund should reconcile the computation with its filed return and identify the specific mistake.
A rectification request should explain the error, set out the relevant tax calculation and include supporting records. Filing the request does not guarantee that the department will accept the claim.
2. Consider an appeal under Section 246A
If rectification does not resolve the issue, the fund should determine whether the relevant order is appealable under Section 246A. Where an appeal is available, it should be filed before the Commissioner of Income-tax (Appeals) within the applicable limitation period.
The grounds of appeal should explain why the demand conflicts with the relevant statutory provisions and the fund’s circumstances. The fund should check the order date, service details and applicable procedural requirements rather than assume that the same limitation period applies to every order.
3. Assess recovery and stay relief separately
A GIFT City AIF facing a surcharge-related tax demand needs more than a routine filing review. It needs a clear compliance record that establishes the fund’s structure, eligibility for tax relief and the basis of its tax computation.
If recovery is underway or imminent, the fund should assess whether a separate application for stay or other recovery relief is necessary. Filing a rectification request or appeal should not be assumed to suspend recovery automatically.
For example, if a processed return adds surcharge to dividend income that qualifies for relief, the fund should document its eligibility, reconcile the demand with the return and explain the statutory basis for rectification. If the issue remains unresolved, it should assess the available appellate remedies.
The relevant statutory references are Section 154 and Section 246A of the Income-tax Act, 1961.
Setindiabiz Support
Setindiabiz supports businesses with IFSC entity setup, corporate structuring, tax-return preparation, income-tax notice responses and regulatory secretarial compliance. For fund managers and Fund Management Entities (FMEs), this support brings together the statutory records, fund-structure documents and tax filings needed to examine a demand and identify possible inconsistencies.
Where a surcharge demand appears inconsistent with the relief available to a qualifying specified fund, Setindianiz experts support the documentation and compliance process required for a considered response. The next step depends on the fund’s eligibility, the nature of the income, the tax computation and the specific notice or order received.
A well-documented compliance position gives fund managers a sounder basis for deciding how to respond.
FAQs
No. The relief applies to qualifying specified funds and eligible income under the relevant statutory provisions. A GIFT City location alone does not establish eligibility.
The Income Tax Department’s guidance provides for nil health and education cess on the tax payable on qualifying specified-fund securities income. This treatment should not be extended to unrelated income or capital gains without checking the applicable provisions.
The fund should review its eligibility, filed return and tax computation. Where an apparent processing error exists, it may seek rectification under Section 154. If the issue remains unresolved, it should assess whether an appeal under Section 246A is appropriate.
No. The fund should separately assess whether a stay or other recovery-relief application is required.
The new Act commenced on 1st April, 2026. Its repeal-and-savings provisions preserve the application of the Income-tax Act, 1961, to relevant earlier tax years and proceedings. The applicable provisions should be checked against the assessment year and nature of the proceeding.
Conclusion
The GIFT City surcharge dispute highlights the need to verify specified-fund eligibility, classify income correctly and review tax computations before accepting a demand. Eligible funds should preserve supporting records and pursue the appropriate remedy promptly where a surcharge appears inconsistent with the law.
