Rule 238 Definitions explained: this guide covers what it means, who it applies to, the step-by-step process, documents required, fees, due dates and penalties in India — so you can stay compliant with confidence and avoid costly mistakes.
The rule 238 definitions in the Income-tax Rules, 2026 build the FATCA and CRS vocabulary — financial account in five limbs, four kinds of financial institution with their 20% and 50% income tests, and the active or passive distinction that decides whether controlling persons are looked through.
What the rule 238 definitions do
Rule 238 is the definitions rule for rules 239 and 240 — the reporting and due diligence rules that implement the FATCA agreement with the United States and the Common Reporting Standard. It is one of the longest rules in the Income-tax Rules, 2026, and nothing in the other two can be applied without it. The 1962 parallel is rule 114F.
This article covers the positive half of the rule 238 definitions — what is a financial account, an institution, a reportable account and a reportable person. The exclusions — excluded accounts, non-reporting and non-participating financial institutions — are dealt with separately.
Financial account in the rule 238 definitions — five limbs
Clause (1): a financial account is an account other than an excluded account maintained by a financial institution, and includes:
| Limb | What it covers |
|---|---|
| (i) | A depository account |
| (ii) | A custodial account |
| (iii) | In the case of an investment entity, any equity or debt interest in the financial institution |
| (iv) | In any other financial institution, an equity or debt interest if the class of interests was established with a purpose of avoiding reporting under rule 239 |
| (v) | Any cash value insurance contract and any annuity contract, other than a non-investment-linked, non-transferable immediate life annuity monetising a pension or disability benefit from an excluded account |
The point that most often surprises a fund manager: under limb (iii) of the rule 238 definitions, any equity or debt interest in an investment entity is itself a financial account. A mutual fund, AIF or portfolio vehicle that is an investment entity is therefore maintaining financial accounts for its unit holders, and must run due diligence on them. Limb (iv) then catches the avoidance case for every other kind of institution — an interest class established with a purpose of avoiding reporting becomes a financial account even where the ordinary limbs would not reach it.
The Explanation carries a set of sub-definitions. A depository account includes commercial, checking, savings, time and thrift accounts and certificates of deposit, and — for accounts other than U.S. reportable accounts — also an account representing specified electronic money products and an account holding central bank digital currencies. A custodial account holds financial assets for the benefit of another person. Equity interest in a partnership means a capital or profits interest; in a trust it means any interest of a settlor or beneficiary, or of any natural person exercising ultimate effective control.
Cash value is the greater of the surrender or termination amount, determined without reduction for surrender charge or policy loan, and the amount borrowable under the contract — with five carve-outs, including a pure death benefit and a personal injury or sickness indemnity.
Financial asset in the rule 238 definitions
Clause (2): financial asset includes a security, partnership interest, commodity, swap, insurance contract or annuity contract, and any interest — including a futures or forward contract or option — in any of them. It does not include a non-debt and direct interest in immovable property. For an account other than a U.S. reportable account it also includes any interest in a relevant crypto-asset.
The four financial institutions
Clause (3): a financial institution is a custodial institution, a depository institution, an investment entity, or a specified insurance company. Each has its own test, and two are quantitative:
| Kind | Test |
|---|---|
| Custodial institution | Holds financial assets for the account of others as a substantial portion of its business, and income from holding financial assets and related services is 20% or more of gross income over the three financial years preceding the year of determination, or the period of existence if shorter |
| Depository institution | Accepts deposits in the ordinary course of a banking or similar business — and, for accounts other than U.S. reportable accounts, also an entity holding specified electronic money products or central bank digital currencies for customers |
| Investment entity | Either (A) primarily conducts, for customers, trading in money market instruments, foreign exchange or securities, individual or collective portfolio management, or otherwise investing, administering or managing financial assets or money; or (B) its gross income is primarily attributable to investing in financial assets and it is managed by another financial institution |
| Specified insurance company | An insurance company, or the holding company of one, that issues or is obligated to make payments with respect to a cash value insurance contract or annuity contract |
The rule 238 definitions use 20% for a custodial institution and 50% for an investment entity, and the measurement windows differ too. The custodial test looks at the three financial years preceding the determination year. The investment entity test looks at the shorter of the three-year period ending on 31 March of the year preceding the determination year, or the period of existence. An entity close to either line has to be re-tested annually, and the answer can change without any change in its business.
Note also limb (B) of the investment entity definition. An entity with no operations of its own becomes an investment entity simply because its income comes from investments and it is managed by a financial institution. That is how a great many holding companies, family vehicles and trusts fall inside the regime.
Reportable account and reportable person in the rule 238 definitions
Clause (6): a reportable account is a financial account identified, under the rule 240 due diligence procedures, as held by:
- a reportable person; or
- an entity not based in the United States with one or more controlling persons that is a specified U.S. person; or
- a passive non-financial entity with one or more controlling persons who are reportable.
Clause (9): a reportable person is a specified U.S. person, or a person resident for tax purposes in any country outside India except the United States — or the estate of such a decedent — excluding a listed entity, a related entity of one, a Governmental entity, an international organisation, a Central bank, and a financial institution.
Clause (8): a reporting financial institution is a financial institution other than a non-reporting one that is resident in India, excluding its branches outside India; and any Indian branch of such an institution that is not resident in India.
Clause (8) of the rule 238 definitions is drafted on a branch footing in both directions. An Indian bank's overseas branch is outside the Indian reporting obligation; a foreign bank's Indian branch is inside it. So the unit of compliance is the Indian footprint, and a group cannot discharge or acquire the obligation by moving accounts between entities without moving them between jurisdictions.
Active or passive — and why it matters
The Explanation to clause (6) carries the distinction that drives the whole look-through. An active non-financial entity satisfies any of eight criteria, of which the first is the substantive one:
- less than 50% of gross income for the preceding financial year is passive income and less than 50% of assets produce or are held to produce passive income;
- its stock is regularly traded on an established securities market, or it is a related entity of such an entity;
- it is a Governmental entity, international organisation or Central Bank, or wholly owned by them;
- it is a holding or group financing company for non-financial subsidiaries — but not if it functions as an investment fund such as a private equity, venture capital or leveraged buyout fund;
- it is a start-up not yet operating, for twenty-four months from initial organisation;
- it is liquidating or reorganising, not having been a financial institution in the past five years;
- it engages primarily in financing and hedging with related non-financial entities; or
- it is an Indian religious, charitable, scientific, artistic, cultural, athletic or educational body, or a professional or trade organisation, that is exempt from income-tax, has no proprietary members, cannot distribute to private persons, and must distribute to a Governmental or non-profit body on dissolution.
Passive income includes dividends, interest, income equivalent to interest, rents and royalties not derived in active conduct, annuities, net gains on financial assets and on derivative transactions, net foreign currency gains, net swap income and amounts received under cash value insurance contracts — but not income of a dealer in financial assets from transactions in the ordinary course of that dealing.
A passive non-financial entity is simply one that is not active. The consequence is substantial: under clause (6)(c), the account is reportable if any controlling person is a reportable person, whatever the entity's own residence. And controlling person is defined widely — the natural person exercising control, including a beneficial owner under rule 9(3) of the PMLA Maintenance of Records Rules, 2005, and for a trust the settlor, the trustees, the protector, the beneficiaries or class of beneficiaries, and any other natural person exercising ultimate effective control. A family trust holding investments is the classic case: passive, and every one of those persons is tested. The rule 238 definitions also point to three 2013 circulars of the RBI, SEBI and IRDA for determining the beneficial owner.
Worked example
| Facts | Position under rule 238 |
|---|---|
| Custodian's asset-servicing income is 24% of gross income over three years | Custodial institution — the test is 20% |
| Holding company with only dividend income, managed by a fund manager | Investment entity under limb (B) |
| Units held by an investor in an Indian AIF | A financial account under limb (iii) |
| Direct interest in an office building | Not a financial asset |
| Interest in a relevant crypto-asset | A financial asset for a non-U.S. reportable account |
| Indian bank's Dubai branch account | Outside the reporting financial institution definition |
| Foreign bank's Mumbai branch account | Inside it |
| Group treasury company financing only non-financial affiliates | Active non-financial entity |
| Private equity fund holding portfolio companies | Not active under the holding-company limb |
| Family trust holding listed securities | Passive; settlor, trustees, protector and beneficiaries all tested |
| Start-up incorporated thirty months ago, still pre-revenue | The twenty-four month concession has expired |
| Tax-exempt Indian charitable trust meeting all five conditions | Active non-financial entity |
Compliance checklist
- Classify the institution against the four kinds before anything else — the rest of the regime follows from it.
- Apply 20% for a custodial institution and 50% for an investment entity, on their different measurement periods.
- Test limb (B) of the investment entity definition for every managed holding or family vehicle.
- Treat units in an investment entity as financial accounts of the holders.
- Identify each account holder's status — reportable person, active or passive non-financial entity.
- For a passive entity, identify every controlling person, using the PMLA beneficial owner rules and the three 2013 circulars.
- For a trust, remember the list runs to settlor, trustees, protector, beneficiaries and any person with ultimate effective control.
- Fix the reporting obligation on the Indian branch footprint, not the group entity.
Common mistakes
- Applying one percentage test to both custodial institutions and investment entities.
- Treating a passive holding vehicle as outside the regime when limb (B) brings it in.
- Overlooking unit holders of an investment entity as account holders.
- Identifying only the trustees of a trust as controlling persons.
- Reporting an overseas branch of an Indian institution.
- Assuming a charitable body is automatically active without the five conditions.
Which year this governs
The Income-tax Rules, 2026 are made under the Income-tax Act, 2025. The 1962 parallel to rule 238 is rule 114F, given for tracing only. The rule 238 definitions carry dates and cross-references from the 2014 FATCA and 2016 CRS implementations forward unchanged. Verify the current text and the FATCA agreement before classifying an entity.
Key Facts About Rule 238 Definitions
- Applies in: All states across India, under the relevant central law.
- Mode: Mostly online via the official government portal.
- Typical timeline: Ranges from a few days to a few weeks depending on the case.
- Non-compliance: May attract penalties, interest or late fees.
- Expert help: TaxClue completes the entire process end to end for you.
What is a financial account?
An account, other than an excluded account, maintained by a financial institution — including a depository account, a custodial account, in the case of an investment entity any equity or debt interest in it, in other cases an equity or debt interest established with a purpose of avoiding reporting, and any cash value insurance contract or annuity contract.
What are the four kinds of financial institution?
A custodial institution, a depository institution, an investment entity, and a specified insurance company.
Over 90% of compliance penalties in India arise from missed due dates — timely handling can save businesses thousands of rupees each year.
Rule 238 Definitions: a key compliance topic in Indian tax and corporate law that businesses and individuals must understand to remain compliant.