Raising funds in the distressed asset sector: ARCs seek better tax treatment for AIFs

By achieving “pass-through” status for AIFs, investors can achieve a better return on their investment | Photo credit: M.photostock

If AIFs are given pass-through status, they will not have to pay tax at entity level. However, their investors will pay taxes.

According to the Securities and Exchange Board of India (SEBI), an AIF is a private pooled investment vehicle (a fund incorporated or incorporated in India), which raises money from sophisticated investors, both Indian and foreign, to invest it in accordance with a specified investment policy for the benefit of its investors.

The Association of ARCs in India, in a representation to the Ministry of Finance, noted that an AIF pools funds from several investors and any income earned from the investment in securities securities (SRs) should logically be treated as investor income. Currently, such income is taxed as business income of AIFs, subject to a maximum tax level of 42.74 percent.

By using ‘pass-through’ status for AIFs, investors can achieve a better return on their investment, aligning the risk with the reward of investing money in riskier, distressed assets. So, more money will flow into distressed debt, ensuring liquidity and better chances of revival of sick units.

“The RBI’s Committee on ARC Sector had in 2021 recommended a pass-through regime for AIFs’ income from investments in SRs. This measure will boost investor sentiment and attract funding in the distressed debt market through securities issued by ARCs and provide depth and liquidity,” said Hari Hara Mishra, CEO of the Association of ARCs in India.

Role of ARCs

ARCs acquire stressed assets, including bad loans, loans showing signs of incipient stress, and charged-off accounts, from banks and financial institutions and implement resolution strategies to maximize recovery and optimize the value of such assets.

An SR is a receipt issued by an ARC to a qualified buyer evidencing the purchase or acquisition of an undivided right, title or interest in the financial asset involved in the securitization.

ARCs have also sought clarity on the tax rate applicable to foreign portfolio investors (FPIs) when they invest in SRs issued by ARCs. They noted that under the Income Tax Act, there is no specific tax rate mentioned for the taxability of interest income of FPIs or the profit received from their investment in SRs.

Published on January 28, 2026