Budget 2025: Capital Gains Tax Rules for ULIPs, FIIs, and AIFs
The Budget 2025 introduced significant changes to the capital gains tax system, particularly affecting Unit Linked Insurance Plans (ULIPs), Foreign Institutional Investors (FIIs), and Alternative Investment Funds (AIFs). These changes aim to bring clarity
Budget 2025Capital Gains TaxUlipsFiisAifsReal EstateFeb 05, 2025
The tax rates and holding periods for different assets remain unchanged, meaning the rules for long-term capital gains (LTCG) and short-term capital gains (STCG) will continue for the financial year 2026 (Assessment Year 2026-27).
Different capital assets such as listed shares, mutual funds, tax-free bonds, debentures, unlisted shares, and real estate are taxed based on the holding period, determining whether the gains are classified as LTCG or STCG.
Changes for Unit Linked Insurance Plans (ULIPs)
From April 1, 2026, ULIPs with annual premiums above Rs 2.5 lakh will be taxed at a 12.5% long-term capital gains (LTCG) rate.
This change aims to bring more clarity to the taxation of ULIPs, which combine insurance with stock market investments.
There was confusion about whether long-term gains on ULIPs, held for over a year, should be taxed as LTCG or treated as income from other sources.
The tax treatment of ULIP gains, especially for high-premium policies, was unclear.
Unlike traditional insurance plans that invest mainly in debt, ULIPs allocate a significant part of the premium to stocks.
This makes it necessary to tax them differently from regular insurance policies.
The Finance Minister announced that ULIPs with annual premiums over Rs 2.5 lakh will now be taxed like equity mutual funds, aligning with the 2021 budget's introduction of taxes on high-premium ULIP returns.
However, uncertainty remained about how these policies would be taxed upon redemption, leading to investor confusion.
The Finance Bill 2025 clarifies this by stating that any amount received from such ULIPs, where the Section 10(10D) exemption does not apply, will be taxed as capital gains.
This rule takes effect from April 1, 2026, impacting the assessment year 2026-27 onwards.
LTCG Tax Hike for FIIs and Specified Funds
The Finance Bill 2025 proposes raising the long-term capital gains (LTCG) tax rate on certain securities from 10% to 12.5%, effective April 1, 2026.
This follows last year's increase to 12.5% for listed shares, equity mutual funds, and business trust units sold by foreign institutional investors (FIIs).
For specified funds and FIIs, LTCG tax rates under section 112A have been aligned with those for residents.
However, for long-term gains not covered under section 112A, the tax rate remains at 10% as per the Finance (No.2) Act, 2024, as proposed in the Finance Bill 2025.
The Bill stated, “It is proposed to amend the provisions of section 115AD to provide that income-tax on the income by way of long-term capital gains on transfer of securities (other than units referred to in section 115AB) not referred to in section 112A, if any, included in the total income, shall be calculated at the rate of 12.5 per cent.” These amendments will take effect from April 1, 2026, and apply in relation to the assessment year 2026-27 and subsequent assessment years.
In 2024, foreign institutional investors (FIIs) invested only Rs 1,600 crore in the Indian stock market on a net basis, a sharp 99% drop from Rs 1.71 lakh crore in the previous year.
FIIs started the year strong, buying Rs 1.12 lakh crore worth of Indian stocks in the first nine months.
However, from October 2024 onwards, they sold stocks worth over Rs 2.63 lakh crore due to an economic slowdown and weaker corporate earnings.
AIFs to Face 12.5% Capital Gains Tax
Income earned by Category I and II Alternative Investment Funds (AIFs) will now be taxed as capital gains at a 12.5% rate.
Previously, there was no clear rule on how this income was taxed.
The definition of “capital asset” under the Income Tax Act has been expanded to include gains made by AIFs.
If this income were treated as business income instead, it would attract a much higher tax—30% for residents and up to 39% for non-residents.
Category I and II AIFs mainly invest in unlisted companies, debt instruments, and infrastructure, while Category III AIFs focus on listed stocks.
Currently, Category I and II AIFs enjoy pass-through taxation, meaning tax is levied at the investor level, not the fund level.
However, Category III AIFs do not get this benefit.
This new tax rule will take effect from April 1, 2026, for the assessment year 2026-27.
Frequently Asked Questions
What is the new tax rate for ULIPs with annual premiums over Rs 2.5 lakh?
From April 1, 2026, ULIPs with annual premiums above Rs 2.5 lakh will be taxed at a 12.5% long-term capital gains (LTCG) rate.
How will the LTCG tax rate change for FIIs and specified funds?
The Finance Bill 2025 proposes raising the long-term capital gains (LTCG) tax rate on certain securities from 10% to 12.5%, effective April 1, 2026.
What is the purpose of these tax changes?
The purpose of these changes is to bring more clarity to the taxation of ULIPs, align tax rates for long-term and short-term capital gains, and ensure fair taxation of different investment vehicles.
How will AIFs be taxed under the new rules?
Income earned by Category I and II Alternative Investment Funds (AIFs) will now be taxed as capital gains at a 12.5% rate from April 1, 2026.
What is the impact of the tax changes on foreign institutional investors (FIIs)?
The tax changes will increase the long-term capital gains (LTCG) tax rate for FIIs and specified funds from 10% to 12.5%, effective April 1, 2026, aligning it with the rates for residents.
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