Section 115AB: Tax on Offshore Fund Units and Capital Gains

Section 115AB of the Income-tax Act, 1961 prescribed special tax rates for qualifying overseas financial organisations earning income from units purchased in foreign currency or long-term capital gains from their transfer. The corresponding provision for the new tax regime is Section 208 of the Income-tax Act, 2025.

Tax rates under Section 115AB

Under Section 115AB(1), an offshore fund's qualifying income is charged at the following special rates. Tax on other income, if any, is calculated separately under the applicable provisions.

The long-term capital gains rate was amended by the Finance (No. 2) Act, 2024, with effect from 23 July 2024. The special rates shown are base rates; applicable surcharge and health and education cess, as well as treaty provisions where relevant, must be considered separately.

Who qualifies as an offshore fund?

The Explanation to Section 115AB defines an overseas financial organisation as a fund, institution, association or body, incorporated or otherwise, established under the laws of a country outside India, that has entered into an arrangement to invest in India with a qualifying public sector bank, public financial institution or mutual fund specified under Section 10(23D), with approval by the Securities and Exchange Board of India for this purpose.

Definitions in the provision

• Unit: A unit of a mutual fund specified under Section 10(23D) or of the Unit Trust of India, as described in the provision.
• Foreign currency: Has the meaning assigned under the Foreign Exchange Management Act, 1999.
• Public sector bank: The term is linked to the meaning referred to in Section 10(23D).
• Public financial institution: The historical text refers to Section 4A of the Companies Act, 1956; interpret this reference with applicable company-law transition provisions.
• Unit Trust of India: The historical definition refers to the Unit Trust of India Act, 1963, and must be read in its legislative context.

These conditions are specific. The fact that a foreign investor holds mutual fund units does not, by itself, establish eligibility for Section 115AB.

Computation and restrictions on deductions

Section 115AB(2) restricts deductions in computing qualifying unit income and gains. In particular, where the gross total income consists only of the specified unit income or long-term capital gains, or both, deductions under Sections 28 to 44C, the specified clauses of Section 57 and Chapter VI-A are unavailable as provided in the section. The second proviso to Section 48 does not apply to the qualifying long-term gains.

Where the offshore fund also has other income, Chapter VI-A deductions, where otherwise admissible, are determined after excluding the qualifying income in the manner required by Section 115AB(2)(b). The tax on that other income is calculated separately under Section 115AB(1)(iii).

Tax deduction at source under Section 196B

For payments governed by the 1961 Act, Section 196B required the person responsible for paying specified income to an offshore fund to deduct tax at the earlier of credit or payment. Its amended rates aligned with Section 115AB: 10% for qualifying unit income, 10% for qualifying long-term gains on transfers before 23 July 2024, and 12.5% for qualifying long-term gains on transfers on or after that date.

For current payments, the relevant withholding provisions of the Income-tax Act, 2025 and applicable treaty documentation should be checked rather than assuming that historical section numbering continues unchanged.

Section 208 of the Income-tax Act, 2025

Section 208 is the corresponding provision under the Income-tax Act, 2025. It provides a 10% rate for qualifying income from units purchased in foreign currency and a 12.5% rate for qualifying long-term capital gains from their transfer, while other income is taxed at the applicable rates. Its full statutory conditions, computation rules and definitions should be read before applying the concession.

Illustration: If a qualifying offshore fund earns Rs. 2,00,000 from eligible units and Rs. 4,00,000 in eligible long-term capital gains taxable at 12.5%, the base tax on these amounts is Rs. 20,000 plus Rs. 50,000, or Rs. 70,000, before applicable surcharge, cess, treaty relief or other adjustments.

Official statutory references

• Income Tax Department: Section 115AB of the Income-tax Act, 1961
• Income Tax Department: Section 196B withholding provisions
• Income Tax Department: Income-tax Act, 2025 (official PDF; see Section 208)
• Income Tax Department: Income-tax Act, 1961 as amended
• Income Tax Department: Tax rates and computation

This article explains the statutory framework in general terms. Actual tax treatment depends on the relevant tax year, investor eligibility, transaction details, domestic amendments and applicable tax treaties.