Key Compliance Framework Introduced for Investment Funds
The Draft Income-tax Rules, 2026 have introduced Rule 274, providing detailed guidelines for investment funds seeking tax benefits under Section 9(12) read with Schedule I. The rule aims to bring greater clarity on eligibility conditions, participation thresholds, reporting requirements, and remuneration structures for fund managers.
The framework is expected to significantly impact foreign and institutional investment funds operating in India by defining how compliance will be assessed and how temporary deviations will be treated.
Look-Through Provision for Institutional Investors
Rule 274 allows a look-through approach where investments are made through an institutional entity. The number of members and participation interest can be determined by looking through such entities if they meet specific conditions, including:
- Independent satisfaction of key Schedule I criteria
- Being set up solely for pooling and investment of funds
- Residency in a country with which India has a tax agreement or notified jurisdiction
This provision provides clarity for global investment structures and helps determine eligibility more accurately.
Relief for Temporary Non-Compliance
The draft rule provides flexibility by ensuring that funds will not lose eligible status due to temporary non-compliance with certain Schedule I conditions if:
- The lapse is beyond the fund’s control and does not exceed 90 days
- The fund is within 18 months of setup or until final closing with bona fide efforts to comply
- The fund is in the process of winding up within a one-year window
- There is a delay of up to 90 days in furnishing required statements
This relaxation is aimed at reducing procedural hardships while maintaining compliance intent.
Definition of Control Threshold
Rule 274 clarifies that a fund will be considered as controlling or managing a business if it holds more than 26% of total share capital, voting power, or interest , directly or indirectly. This provides a clear benchmark for determining management control.
Fund Manager Remuneration Norms
The rule prescribes minimum remuneration thresholds for fund managers:
0.10% of assets under management (AUM) for certain Category I FPIs under regulations of the Securities and Exchange Board of India
In other cases, remuneration may be the higher of:
- 0.30% of AUM
- 10% of profits above the specified hurdle rate
- 50% of management fee after operational expenses where multiple managers are involved
Funds can apply to the Central Board of Direct Taxes for approval if they seek to pay lower remuneration, subject to review.
Reporting and Documentation Requirements
Fund managers must obtain an accountant’s report for activities undertaken for the fund and submit it in the prescribed form by the specified date, in addition to existing reporting obligations. The provisions ensure enhanced transparency and accountability.
The rule also clarifies that a fund manager will not be treated as a connected person merely because it undertakes fund management activities for the fund.
Clarification on Fixed Fee Treatment
Any fixed remuneration paid to a fund manager that is not linked to profits will be excluded from profit calculations if Schedule I conditions are met and the fee arrangement is agreed in writing at the start of the fund management activity.
Definitions Introduced
Rule 274 defines key terms including:
- Assets under management (AUM): Annual average of monthly averages of opening and closing balances of managed assets
- Management fee: Amount certified by an accountant
- Specified hurdle rate: Pre-defined profit threshold triggering profit-linked remuneration
Impact on Investment Fund Industry
The introduction of Rule 274 is expected to strengthen regulatory certainty for investment funds while balancing compliance with operational flexibility. By clarifying eligibility tests, control thresholds, and remuneration structures, the draft rule aims to align India’s tax framework with global investment practices while safeguarding tax administration.
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