This judgement explains the scheme of taxation of Category II Alternative Investment Funds (AIF).

It held that income from interest and capital gains earned by a Category II Alternative Investment Fund (AIF) was exempt under section 10(23FBA) of the Act. An AIF could not be treated as a Venture Capital Fund (VCF) and such a treatment given by the AO was held to be improper.

Furthermore, merely because a receipt was labelled as ‘processing fee’, the same would not partake the nature of business income so as to tax it in the hands of the AIF. The processing fee was held to be intrinsically connected with the investments made by the assessee-AIF in NCDs and found to represent an additional return earned on such investments to compensate for the underlying investment risk. Thus, the classification of the said income as ‘income from other sources’ as done by the assessee-AIF was upheld and the exemption under section 10(23FBA) was held to be allowable on the same.