[BREAKING] Taxation of Category III Alternative Investment Funds: Delhi HC reads down CBDT Circular 13/2014 [Read Order]

The Delhi HighCourt delivered a major decision holding that CBDT Circular 13/2014 must be read down under Section 164 of the Income Tax Act. The Court clarified that Explanation 1’s requirement for beneficiaries to be expressly stated and identifiable must be read in light of SEBI regulations and the principle of determinability of investor shares.

The petition challenged the tax department’s practice of applying the Maximum Marginal Rate (MMR) to Category III AIFs on the basis that the original trust deed lacked named investors, a requirement under Circular 13/2014 that conflicted with SEBI rules and rendered the trust indeterminate for tax purposes. The Court observed that requiring named beneficiaries when SEBI prohibits pre‑registration disclosure was impossible. The petitioner argued that the Circular’s imposition of highest‑slab rates contravened legislative intent. The case underscores tension between tax directives and capital markets regulation.

In its analysis, the High Court reaffirmed precedents in CIT v. India Advantage Fund‑VII (Karnataka HC, 2021) and CIT v. TVS Shriram Growth Fund (Madras HC, 2022), holding that Section 164 focuses on whether beneficiary shares are determinable through proportional NAV allocations, not whether names appear in the trust deed. The Court emphasized that proportional entitlement calculations satisfy the statutory test, ensuring that tax liability is based on clear economic interest rather than technical compliance failures.

Applying the Latin maxim  lex non cogit ad impossibilia, the bench held that SEBI’s prohibition on naming investors before registration makes the Circular’s naming requirement unworkable and must be read down. It struck down paragraph 6 of the Circular, which attempted to exclude jurisdictions with contrary rulings, as “baffling and abhorrent,” insisting that constitutional court decisions bind uniformly across India.

This is among the first high‑court rulings to effectively read down Circular 13/2014, aligning Category III AIF taxation with long‑standing judicial and regulatory frameworks. By confirming that determinable investor shares suffice, the judgment prevents arbitrary invocation of MMR and is expected to influence Clause 307 of the proposed Income Tax Bill, 2025, which seeks to codify Explanation 1.

The bench also noted that the public interest as also the interest of the revenue would be sub-served, in our considered opinion, by exercising our jurisdiction under Article 226 of the Constitution of India.

It was added that, “For the same reason, the impugned CBDT Circular No.13/2014 also would be amenable to exercise of jurisdiction under Article 226 of the Constitution of India, 1950 since the recitals of Para 6 are contrary to the well settled principles of law.”

Resultantly, the writ petition is allowed, the impugned order dated 27.06.2024 of the respondent no.2/Board for Advance Rulings was quashed and set aside and simultaneously, the clarification contained in CBDT Circular No.13/2014 dated 28.07.2014 was directed to be read down to conform to the above analysis and conclusion.

Industry participants are already reviewing trust deeds and compliance processes in anticipation of wider application of this reasoning.

Support our journalism by subscribing to Taxscan premium. Follow us on Telegram for quick updates