📚 PASS Investment Adviser (Level 2) Difficulty: Beginner ℹ️ Info   ~5 min read
📌 Chapter 12.6 — Alternative Investment Funds

Imagine you are reviewing the tax history of a high-net-worth client’s portfolio, specifically looking at their investments in a Category-II AIF established in 2017. Your client mentions that the fund reported significant capital losses in 2018, which they expected to offset against their personal capital gains. However, you find no record of these losses being reflected in their tax filings for that year. This discrepancy is not a reporting error by the fund manager, but a direct consequence of the regulatory framework that existed before the 2019 Finance Act amendments.

Prior to the 2019 legislative changes, AIFs faced a significant ’trapped loss’ issue. While the pass-through status allowed for the distribution of income, it did not explicitly authorize the transfer of non-business losses from the fund to the investor. Consequently, these losses remained stuck at the fund level, where they were effectively useless because the fund itself was exempt from tax under Section 115UB.

The fund had no tax liability to offset, and the investors had no mechanism to claim the loss, creating a structural inefficiency for early participants in private equity and venture capital funds.

From a valuation and tax planning perspective, this historical limitation reminds us why legislative timing is critical. If you are building a model to project the tax-adjusted returns of a legacy investment, you must treat pre-2019 losses as ‘sunk costs’ that provide no tax shield for the investor.

For an analyst, this means the effective internal rate of return (IRR) for early investors in these funds was often lower than models might suggest today, as they bore the full tax burden on gains without the benefit of offsetting prior-year losses. Understanding this history is essential when conducting due diligence on funds that have been active across both the pre- and post-2019 regulatory regimes.

Consider an investor who entered a fund in 2017 and incurred losses until 2019. Under the old regime, those losses essentially vanished into the regulatory void, offering no relief against their external income. Today, the rules have evolved to allow for loss carry-forward, but this privilege remains strictly prospective. When advising clients with long-standing AIF holdings, ensure that your tax models account for this historical ‘dead zone’ to avoid overstating the potential for retrospective tax recovery.1

Nuance

⚠️ Nuance
Many candidates mistakenly believe that because current law allows for the pass-through of non-business losses, this right is retroactive to the inception of the AIF regulatory framework. In practice, tax authorities treat these provisions as prospective, meaning losses incurred in years prior to the 2019 amendment remain permanently trapped at the fund level. A sharp analyst distinguishes between the fund’s current ability to pass through losses and the historical inability to do so, as this materially affects the client’s historical tax basis.

Check Your Understanding

Practice Question 1

An investor has held units in a Category-II AIF since 2016. The fund reported non-business losses in 2017 and 2018. How should these specific losses be treated when the investor calculates their tax liability for the current financial year?

Practice Question 2

Which of the following best describes the tax treatment of Category-I and Category-II AIFs regarding losses incurred in the fiscal year 2022?

This is a companion read for Section 12.6 — Alternative Investment Funds from PASS Investment Adviser (Level 2) by Akhilesh Gururani, available on Amazon Kindle.

Copyright © 2026 Akhilesh Gururani. All rights reserved.

  1. The carry-forward of losses is subject to specific holding period requirements, generally mandating that the investor holds the units for at least 12 months to qualify for the pass-through benefit. ↩︎