Budget 2026 wishlist: AIF industry seeks level tax field for private credit, Category III funds

Budget 2026: With the Union Budget 2026 approaching, the alternative investment industry is stepping up its push for tax reforms, arguing that the current framework is holding back the growth of private credit and creating uncertainty for Category III alternative investment funds (AIFs). The Indian Venture and Alternate Capital Association (IVCA), which represents AIFs and private capital players, has urged the finance ministry to use the Budget to bring parity in taxation and provide long-awaited clarity on how complex fund structures are treated under the Income-Tax Act.

At the centre of IVCA’s appeal is the treatment of private credit funds, which finance segments such as MSMEs, startups and infrastructure -- areas that typically struggle to access traditional bank lending. While these funds play a growing role in supporting India’s real economy, they are taxed more harshly than comparable investment vehicles. 

Currently, private credit AIFs and debt-oriented funds are taxed as ordinary income, often at the highest marginal rate of around 39%. By contrast, certain mutual fund schemes that qualify as “equity-oriented” due to limited hedged equity exposure enjoy significantly lower capital gains tax rates.

Industry executives argue that this gap discourages domestic investors from committing long-term capital to higher-risk but economically critical sectors. In its Budget 2026 proposals, IVCA has called for a level playing field across debt-like instruments, recommending that AIFs, mutual funds and bonds face similar tax treatment when their risk and return profiles are broadly aligned. The association has also suggested that tax rules should consider a fund’s actual net equity exposure, rather than its technical classification, to prevent distortions created by derivative-heavy strategies.

Another key area of concern is the taxation of Category III AIFs, which include long-only equity funds as well as quantitative and derivatives-based strategies. Despite their growing presence in India’s capital markets, these funds do not have a dedicated framework under the Income-Tax Act. Most are structured as trusts and end up being governed by private trust taxation rules—regimes that were never designed for institutional investment vehicles. According to IVCA, this mismatch has led to inconsistent interpretations, prolonged disputes and, in some cases, the risk of double taxation, where income is taxed both at the fund level and again in the hands of investors.

The scale of the issue is underlined by regulator data. As of September 2025, total commitments to AIFs stood at Rs 15.05 lakh crore, with investments at Rs 6.11 lakh crore. Category III AIFs accounted for nearly Rs 3 lakh crore in commitments, reflecting their rising role in India’s investment landscape.

As Budget 2026 discussions gather pace, IVCA believes targeted tax changes could unlock the next phase of growth for alternative capital. Clearer rules, predictable outcomes and fairer taxation, the industry argues, would not only attract more domestic money into private credit and sophisticated strategies, but also strengthen India’s ambition to build a deeper, more resilient capital market ecosystem.

Court breather

In 2025, the Delhi High Court resolved a long-standing dispute over the tax treatment of Category III Alternative Investment Funds (AIFs), bringing major relief to the industry. In its ruling in the Equity Intelligence AIF Trust case on July 29, the court held that such funds cannot be treated as “indeterminate trusts” merely because investor names are not listed in the trust deed, as long as their beneficial interests can be clearly established through other records.

The judgment effectively read down CBDT Circular No. 13/2014, which had earlier prompted tax authorities to impose the maximum marginal tax rate of nearly 40% on these funds. The court clarified that investor identities and profit shares need not appear in the deed itself and can be evidenced through contribution agreements, information memoranda and SEBI-mandated registers.

As a result, Category III AIFs will now be taxed as determinate trusts, allowing income such as long-term capital gains to be taxed at the concessional 12.5% rate plus surcharge. The ruling boosts compliance clarity and strengthens investor confidence in the AIF ecosystem.