Direct Tax Laws & International Taxation · Assessment of Various Entities

Assessment of Business Trusts and Investment Funds for CA Final

Updated 5 October 2026 · Fact-checked

Business trusts (REITs, InvITs) and Category I and II investment funds are pass-through vehicles. Specified income is exempt in the vehicle and taxed in the unit holder's hands in the same nature. Income not passed through, such as a fund's business income, is taxed in the vehicle. To solve a question, split each income, decide who bears tax, then apply TDS.

Understand Assessment of Business Trusts and Investment Funds

A pass-through vehicle pools money from many investors but does not want a layer of tax on top of the investors' own tax. So the law looks through the vehicle to the unit holders. Income that passes through is exempt in the vehicle and taxed once, in the unit holder's hands.

A business trust is a REIT or InvIT registered with SEBI and listed on a recognised stock exchange. It holds assets through special purpose vehicles (SPVs) or directly. The main income it earns is interest from SPVs, dividend from SPVs, and rent from real estate assets held directly by the REIT. Interest and that directly held rent pass through. Dividend passes through only where the SPV has not opted for the concessional tax regime. Then it is exempt in the trust and taxed in the unit holder's hands. If the SPV has opted for the concessional regime, the dividend is taxed in the trust and does not pass through. Income that is not of a pass-through kind, such as capital gains of the trust, is taxed in the trust itself at the rates applicable to it. The distribution of that income received by the unit holder is not taxed again in the unit holder's hands.

An investment fund here means a Category I or Category II Alternative Investment Fund under the SEBI AIF regulations. All its income other than business income (profits and gains of business or profession) passes through. That means interest, dividend, rent, capital gains and every other non-business income is exempt in the fund and chargeable in the unit holders' hands in the same nature. The unit holder is taxable on this income whether or not the fund actually distributes it. Its business income is taxed in the fund itself, and the unit holder is not taxed again on that part. Category III AIFs do not get this pass-through treatment.

The rule for unit holders is simple. Pass-through income is treated as the unit holder's income of the same nature and in the same proportion as it was in the vehicle. For a business trust, this applies to the income paid or credited to the holder. A non-resident unit holder is taxed at the rates that apply to that kind of income and to that person. The vehicle deducts tax at source only on the pass-through income it actually pays or credits, and gives the unit holder a statement of the income and tax deducted.

Losses stay where they arise. A fund's business loss is carried forward in the fund. It is not passed to unit holders. A unit holder who sells units soon after buying also has special limits on setting off a loss on those units. Apply these limits only as the Act states them.

Key rules to remember

Pass-through rule (business trust): Interest / rent from directly held real estate: exempt in trust → taxable in unit holder in same nature. Dividend: same treatment only if the SPV has not opted for the concessional tax regime; if it has opted, dividend is taxed in the trust; Taxable in the unit holder for the tax year in which it is paid or credited. Always check whether the SPV has opted for the concessional regime before treating dividend as pass-through.
Pass-through rule (investment fund): All income of Cat I / II AIF other than business income → exempt in fund → taxable in unit holder in the same nature; This covers interest, dividend, rent, capital gains and other non-business income. It is taxable in the unit holder whether or not it is distributed. Business income is taxed in the fund. Do not tax it again in the unit holder.
Unit holder's share: Unit holder's income = Pass-through income × (Units held ÷ Total units), by nature; For a business trust, use the actual amount paid or credited to the holder. For an investment fund, use the holder's share of the fund's pass-through income, whether or not it is distributed.
TDS on pass-through income: Resident unit holder: 10% on business trust interest and rent, and 10% on investment fund income. Non-resident unit holder: rate specified in the Act for that nature of income (a concessional rate applies to certain SPV interest on specified conditions); investment fund income at rates in force; The rate depends on the nature of income and residential status. TDS is deducted only on income actually paid or credited. For a non-resident, confirm the rate and its conditions from the Act instead of assuming a flat rate.
Non-pass-through income: Capital gains of a trust and business income of a fund → taxed in the vehicle at its applicable rates; For a fund's business income, the unit holder is not taxed again. For a trust's capital gains, the distribution received by the unit holder is not taxed again.
Losses: Fund's business loss: carried forward in the fund, not allocated to unit holders; Do not set off a fund's loss against a unit holder's income.

How to solve Assessment of Business Trusts and Investment Funds questions

Use the same sequence for any question on a REIT, InvIT or AIF, whether it asks about the vehicle, the unit holder, or both.

1Identify the vehicle: business trust (REIT or InvIT), or a Category I or II AIF. If it is Category III, state that the pass-through rules do not apply.
2List every income of the vehicle and label its nature: interest, rent, dividend, capital gains, business income.
3Decide for each item whether it passes through or is taxed in the vehicle. For business trusts, interest and rent from directly held real estate pass through. Dividend passes through only if the SPV has not opted for the concessional tax regime. For AIFs, everything except business income passes through.
4Compute the tax in the vehicle on the non-pass-through items using the rate that applies to that item and that entity.
5Allocate the pass-through income to each unit holder by units held, keeping the nature of the income.
6Compute the unit holder's tax on that income at their own rate, with the correct residential status. Do not tax a fund's business income, or a trust's taxed capital gains, again in the unit holder's hands.
7Apply TDS on the pass-through income paid or credited, at the rate for that nature of income and residential status, and note the tax is credited to the unit holder.
8State any loss rule, then write a one-line conclusion.

Quickest way: Two-column split

When to use it: Use this when time is short and the question lists several incomes of a REIT, InvIT or AIF.

Draw two columns: 'Taxed in the vehicle' and 'Passes to unit holder'.
Place each income in a column by its nature, using the rules for trust or fund.
Total the first column and tax it in the vehicle.
Take the second column, apply the holder's share, and compute TDS.
Write the conclusion: single tax, no double tax on the same income.

Common mistakes in Assessment of Business Trusts and Investment Funds

Taxing the same income both in the trust or fund and in the unit holder.
Students forget the purpose of pass-through treatment.
Fix: Use the two-column split. Each income appears in only one column.
Treating all income of an AIF as pass-through, including business income.
Students remember 'AIFs are pass-through' and stop there.
Fix: State that business income is taxed in the fund and only the rest passes through.
Applying the pass-through rules to a Category III AIF.
Students read 'investment fund' loosely.
Fix: Say at the start that pass-through applies to Category I and II only.
Changing the nature of income in the unit holder's hands, for example treating rent as interest.
Students focus on the unit rather than the underlying income.
Fix: Keep the same nature and proportion as in the vehicle, as the Act requires.
Passing a fund's business loss to unit holders.
Students assume gains and losses both flow through.
Fix: Say the loss is carried forward in the fund. Only income passes through.
Ignoring TDS or applying one flat rate to every nature of income and to resident and non-resident holders alike.
Students remember '10%' and overlook the nature of income and residential status.
Fix: Check residential status and the nature of income first. Resident: 10% on business trust interest and rent, and 10% on investment fund income. Non-resident: the rate the Act specifies for that nature of income, and rates in force on investment fund income. TDS applies only on amounts paid or credited. Confirm the rate and its conditions for the specific income.

Worked examples

Example 1

A listed REIT earns ₹40,00,000 as interest from its SPVs and ₹20,00,000 as rent from a property it holds directly. It also earns ₹10,00,000 as long-term capital gains on sale of a property. It distributes the interest and rent in full. Mr. Rao, a resident, holds 5% of the units. Explain the tax treatment and compute Mr. Rao's pass-through income and TDS.

Show the solution

The vehicle is a business trust (REIT). Interest and rent from directly held property pass through. Capital gains do not pass through, so they are taxed in the trust at its applicable rates.
Interest and rent are exempt in the trust's hands and are taxable in the unit holders' hands in the same nature.
Mr. Rao's share of interest = ₹40,00,000 × 5% = ₹2,00,000.
Mr. Rao's share of rent = ₹20,00,000 × 5% = ₹1,00,000.
Total pass-through income = ₹2,00,000 + ₹1,00,000 = ₹3,00,000.
TDS at 10% (resident, business trust interest and rent) on ₹3,00,000 = ₹30,000. TDS applies because the full amount is paid or credited to him. Mr. Rao gets credit for this on his own return.
The ₹10,00,000 long-term capital gains is taxed in the trust at the rate applicable to long-term capital gains, so the trust's tax = ₹10,00,000 × that rate (use the rate given in the question). Mr. Rao is not taxed again on any distribution he receives out of this income.

Answer: Mr. Rao is taxed on ₹2,00,000 interest and ₹1,00,000 rent (total ₹3,00,000) at his own rates. TDS is ₹30,000. The ₹10,00,000 capital gains is taxed in the trust at the applicable long-term capital gains rate (₹10,00,000 × rate), and Mr. Rao is not taxed again on its distribution.

Example 2

A Category II AIF has net business income of ₹30,00,000 and interest income of ₹50,00,000 in the tax year. It has also brought forward no loss. Ms. Iyer, a resident, holds 10% of the units and the entire interest is paid out. State what is taxed in the fund, what is taxed in Ms. Iyer's hands and the TDS. Then say what happens if the fund instead has a business loss of ₹4,00,000.

Show the solution

A Category II AIF is an investment fund, so all its income other than business income passes through.
Business income ₹30,00,000 is taxed in the fund. Ms. Iyer is not taxed on it.
Interest of ₹50,00,000 is non-business income. It is exempt in the fund and passes through to unit holders. It is taxable in their hands whether or not it is distributed.
Ms. Iyer's share = ₹50,00,000 × 10% = ₹5,00,000, taxed as interest income in her hands at her own rate.
TDS at 10% (resident, investment fund income) applies on the amount paid or credited. Here the entire interest is paid out, so TDS = ₹5,00,000 × 10% = ₹50,000. She claims credit for it. Had part of the interest not been paid or credited, TDS would apply only on the part paid or credited, but her income would still be ₹5,00,000.
If the fund instead had a business loss of ₹4,00,000, the loss stays in the fund. It is carried forward there against future business income and is not allocated to Ms. Iyer.

Answer: The fund pays tax on ₹30,00,000 business income. Ms. Iyer is taxed on ₹5,00,000 interest, with TDS of ₹50,000. A business loss would stay in the fund.

Exam tips

Begin every answer by naming the vehicle and the pass-through rule. This earns marks in the provision-facts-conclusion format.
In case-scenario MCQs, look for the vehicle category. A Category III AIF is the usual trap.
Always show the income split in two columns. The examiner can then award marks for each item.
Write TDS separately for resident and non-resident holders, and tie the rate to the nature of income and residential status.
If the Act's exact conditions are not in your memory, state the rule in words and avoid guessing a section number.

Practice questions from Assessment of Various Entities

Assessment of Business Trusts and Investment Funds in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

CS ProfessionalTaxation of Unit Holders and Business Trusts

Assessment of Business Trusts and Investment Funds: frequently asked questions

What is pass-through taxation for a business trust?

It means certain income of the trust, such as interest and rent from directly held real estate, is exempt in the trust and taxed in the unit holders' hands. The nature of the income is preserved. This avoids a second layer of tax at the trust level.

Which investment funds get pass-through treatment?

Category I and Category II Alternative Investment Funds under SEBI regulations. Their income other than business income passes through to unit holders. Category III funds do not get this treatment.

Is business income of an investment fund taxed in the unit holder's hands?

No. Business income of the fund is taxed in the fund itself. The unit holder is not taxed again on that part.

Can a fund's loss be set off by the unit holder?

No. A fund's business loss is carried forward in the fund and is not passed to unit holders. There are also special limits on loss from selling units soon after buying them.