Section 10(4D)-Income of a Fund on Transfer of Capital Asset

Section 10(4D) of the Income Tax Act, 1961 in India provides an exemption for certain income earned by specified funds on the transfer of capital assets or other income, such as dividends or interest, derived from securities held by the fund. This provision was introduced to facilitate the operations of specified funds, particularly those established in International Financial Services Centres (IFSCs) like GIFT City, Gujarat, to attract foreign investment and promote financial services in India.

Provisions of Section 10(4D)

Exemption:

• Any income earned by a specified fund that is attributable to units held by non-residents (not being a permanent establishment in India) or to the investment division of an offshore banking unit is exempt from income tax to the extent specified. This includes:
• Income from the transfer of a capital asset (capital gains) on a recognized stock exchange located in an IFSC, where the consideration is paid or payable in foreign currency.
• Income from securities (e.g., interest, dividends) held by the fund, attributable to units held by non-residents.

Specified Fund:

• • A fund that qualifies as a Category-III Alternative Investment Fund (AIF) or a fund established or incorporated in an IFSC and meets the following conditions:
  • It is registered with the Securities and Exchange Board of India (SEBI) or regulated under the International Financial Services Centres Authority (IFSCA).
  • It is located in an IFSC (e.g., GIFT City, Gujarat).
  • Its income is derived from investments made in India or abroad, subject to specified conditions.

Conditions:

• • The income must be attributable to units held by non-residents (excluding permanent establishments in India) or the investment division of an offshore banking unit.
  • For capital gains, the transfer of the capital asset must occur on a recognized stock exchange in an IFSC, and the consideration must be in foreign currency.
  • The fund must comply with regulations under the IFSCA or SEBI, including any conditions prescribed by the Central Government.
  • The exemption applies to the extent the income is attributable to non-resident unitholders, based on the proportion of units held by them.

Scope of Exemption:

• • Capital gains (short-term or long-term) from the transfer of securities (e.g., shares, bonds, derivatives) on an IFSC stock exchange.
  • Interest or dividend income from securities held by the fund, to the extent attributable to non-resident unitholders.
  • The exemption does not apply to income attributable to units held by residents or permanent establishments of non-residents in India.

Example of Section 10(4D)

Scenario:

• Facts:
  • A Category-III AIF, XYZ Global Fund, is registered with the IFSCA and operates from GIFT City, Gujarat (an IFSC).
  • The fund has 70% of its units held by non-residents (e.g., foreign investors in the USA) and 30% by resident Indian investors.
  • In FY 2024-25, the fund earns:
    • ₹10,00,000 as long-term capital gains from the transfer of shares on the India International Exchange (IFSC Exchange) in GIFT City, with consideration paid in USD.
    • ₹5,00,000 as dividend income from securities held in its portfolio.
    • ₹3,00,000 as interest income from bonds held by the fund.
• Tax Treatment:
  • Capital Gains:
    • The ₹10,00,000 capital gains are attributable to the proportion of units held by non-residents (70%).
    • Exempt portion: ₹10,00,000 × 70% = ₹7,00,000 is exempt under Section 10(4D) because the transfer occurred on an IFSC stock exchange, and the consideration was in foreign currency.
    • Taxable portion: ₹10,00,000 × 30% = ₹3,00,000 (attributable to resident unitholders) is taxable in the hands of the fund under the head “Capital Gains.”
  • Dividend Income:
    • Exempt portion: ₹5,00,000 × 70% = ₹3,50,000 is exempt under Section 10(4D) for non-resident unitholders.
    • Taxable portion: ₹5,00,000 × 30% = ₹1,50,000 is taxable for resident unitholders.
  • Interest Income:
    • Exempt portion: ₹3,00,000 × 70% = ₹2,10,000 is exempt under Section 10(4D) for non-resident unitholders.
    • Taxable portion: ₹3,00,000 × 30% = ₹90,000 is taxable for resident unitholders.
• Summary:
  • Total exempt income: ₹7,00,000 (capital gains) + ₹3,50,000 (dividends) + ₹2,10,000 (interest) = ₹12,60,000.
  • The fund must report the taxable portion (₹3,00,000 + ₹1,50,000 + ₹90,000 = ₹5,40,000) in its tax return, subject to applicable tax rates (e.g., 20% for long-term capital gains on listed securities, plus surcharge and cess).

Another Scenario:

• A specified fund in GIFT City has 100% units held by non-residents. It earns ₹20,00,000 in short-term capital gains from the sale of derivatives on the IFSC Exchange in foreign currency.
• Tax Treatment: The entire ₹20,00,000 is exempt under Section 10(4D) since all units are held by non-residents, and the transaction meets the conditions of being on an IFSC exchange with foreign currency consideration.