FoFs are taxed based on the structure of the underlying AIF. Category I and Category II AIFs, including FoFs, set up under these categories, generally enjoy pass-through taxation, where income, other than business income, is taxed in the hands of investors rather than at the fund level. Category III AIFs, on the other hand, do not have pass-through status and are taxed at the fund level. This makes them more tax inefficient compared to the other two categories as the tax rates for a Category III AIF are almost double those for Category I and Category II.
Fund of funds emerges as workaround to Sebi’s AIF cap of 1,000 investors
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