An Alternative Investment Fund (AIF) refers to a privately pooled investment vehicle established or registered in India. These are intended for wealthy individuals, institutions, or experienced investors, whether Indian, NRI, or foreign investors. It collects funds from investors to invest in non-traditional assets, such as private equity, venture capital, and real estate.
AIFs are regulated by the SEBI AIF Regulations 2012, and are structured as trusts, companies, or LLPs. It offers alternative investment opportunities beyond traditional options such as mutual funds or stocks. In this blog, we will learn more about what Alternative Investment Funds are for NRIs.
Key Takeaways
- Alternative Investment Funds are privately pooled investment vehicles started or registered in India. Funds are collected from sophisticated investors and invested according to a specific policy to benefit the investors, whether NRI, Indian, or foreign.
- AIFs invest in asset classes like private equity, real estate, and venture capital, with a minimum investment requirement of Rs. 1 crore.
- AIFs are divided into three categories based on their investment strategy and regulatory classification: Category I, Category II, and Category III.
What are Alternative Investment Funds?
Alternative Investment Funds (AIFs) are private pooled investment vehicles regulated by the SEBI under the AIF Regulations, 2012. These are meant for institutions, wealthy individuals, or experienced investors, including Indians, NRIs, or foreigners. A professional fund manager manages AIFs, and it has its own set of strategies and risks.
These funds primarily target high-net-worth individuals (HNIs), with a minimum investment requirement of Rs 1 crore. Unlike traditional stocks and bonds, AIFs offer access to a wide range of assets. It provides the benefit of portfolio diversification and the potential for higher returns. However, it also carries a high risk and has longer lock-in periods.
What are the Types of Alternative Investment Funds in India?
The AIF in India is divided into three categories: Category I, Category II, and Category III. The classification is done based on their investment strategy and regulatory classification. Each category focuses on different asset classes and has various purposes. Let's understand each category in detail:
Category I AIF
Category I focuses on investing in areas that support long-term economic growth and improve social welfare. This category aims to provide support to the sectors that help with the country's growth. Category I AIFs take a long-term view and may accept higher risks in exchange for potentially substantial returns by investing in high-growth sectors, such as early-stage businesses and infrastructure projects.
Due to their role in the country's development, these are often encouraged by governments through various incentives, like tax benefits, regulatory support, or relaxed investment norms.
Category II AIF
Category II AIF focuses on investing in funds that are not classified under Category I and III, primarily investing in private businesses, debt instruments, and other structured strategies. Instead of focusing on early-stage or socially driven sectors, it offers a middle ground targeting companies with strong fundamentals that need capital for expansion, restructuring, or long-term growth.
These funds can operate with flexibility and are subject to the standard compliance requirements of SEBI. Additionally, these funds don't get special regulatory incentives and are also not permitted for leverage, except for routine operational needs.
Category III AIF
Category III AIFs are for investors who want high returns through complex and actively managed strategies. Investments can be made in instruments like derivatives, structured credit, and arbitrage trades, and can use leverage. Category III AIFs use aggressive and fast-moving strategies that aim to make money regardless of the market's movement.
These funds are ideal only for experienced and well-informed investor because of their high-risk nature. The table below shows some common examples of each category:
| Category I AIF |
Category II AIF |
Category III AIF |
- Venture Capital Funds.
- SME Funds
- Infrastructure Funds.
- Social Venture Funds.
|
- Private Equity Funds.
- Debt Funds.
- Real Estate Funds.
|
- Hedge Funds.
- Derivatives-Based Funds.
- Private Investment in Public Equity (PIPE).
|
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What are the Benefits of Investing in an AIF?
Investing in AIF offers several benefits to the NRI, Indian, or foreign investors, including:
Low Volatility
AIFs are not affected by daily fluctuations in the stock market, making them an ideal investment option for many investors. Their valuations aren't as affected by short-term news or investor sentiment, as a significant portion of their portfolio often includes private assets. Although not entirely risk-free, investment in AIFs usually provides a smoother experience compared to publicly traded stocks, making it appealing for those seeking stability during uncertain periods.
Solid Returns
AIFS stands out by exploring investment options beyond traditional markets. Instead of just focusing on publicly traded companies, they invest in private equity, venture capital, and niche debt deals. These areas often offer greater return potential, especially when opportunities are spotted early. Unlike regular investment funds that follow standard benchmarks, AIFs allow fund managers to take a more selective and strategic approach. While this flexibility can lead to better performance, it also brings unique risks.
Diversification
Effective diversification means more than just owning different stocks. True diversification involves investments across various asset classes that respond differently to market changes. AIFs can include private credit, real estate, startup investments, and unique strategies that often perform independently of traditional markets. This added diversification can strengthen a portfolio, particularly during tough times when public markets are under pressure.
Who Can Invest in AIFs in India?
An investor seeking to diversify their portfolio can invest in an Alternative Investment Portfolio. Here are the individuals who can invest in an AIF in India, provided they meet the eligibility criteria:
- Resident Indians, NRIs, and foreign nationals can invest in AIFs.
- AIFs have a minimum lock-in period of three years.
- For investors, the minimum investment limit is Rs. 1 crore. On the other hand, for directors, employees, and fund managers, the minimum investment amount is Rs. 25 lakh.
- Each scheme has a limit of 1000 investors. One exception is angel funds, where the number of investors can reach 49.
What is the Tax Treatment of AIFs in India?
AIFs in India are taxed based on their category. AIFs category I and II enjoy pass-through taxation, while Category III is taxed at the fund level. Here is a table showing the tax implications of Alternative Investment Funds in India:
| Aspect |
Category I and II AIF |
Category III AIF |
| Pass-through status |
Yes (except for business income) |
No |
| Capital Gains |
Taxed in the investor's hand based on the type:
- STCG: 15%
- LTCG: 10% (listed) and 20% (unlisted)
|
Taxed at the fund level:
- STCG: 15% (listed).
- LTCG: 10% (listed).
- Others: according to the applicable rates.
|
| Dividend Income |
Taxed in the hands of investors based on the slab rate. |
Taxed at the fund level as ordinary income. |
| Interest Income |
Taxed according to the investor's income tax slab. |
Taxed at the fund level
(~ 30% base + surcharge/cess, up to 42.7%).
|
| Business Income |
Taxed at the fund level (if applicable). |
Taxed at the fund level. |
| Withholding Tax (TDS) |
- For resident investors: 10%.
- For non-resident investors: DTAA or 10% (whichever is lower).
|
Not applicable as income is taxed at the fund level. |
| Investor Tax Liability |
Investors pay tax on distributed income (except business income). |
No tax on distributions; investor receives post-tax returns. |
| Recent Updates (FY 2025-2026) |
All securities held by Category I and II AIFS are to be treated as capital assets (clarified in Budget 2025) |
No change in structure; remains taxed at the minimum marginal rate. |
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The Bottom Line
AIFs offer investors a unique opportunity to diversify their portfolios with non-traditional assets such as private equity and venture capital. Although it offers higher returns but it also carries more risks and longer lock-in periods. Investors, specifically high-net-worth individuals (HNIs), must seek help with AIFs to understand complex investment strategies and market volatility.
Contacting an expert can help you get guidance on AIF investments and the risks associated with them. One such expert is Savetaxs. We have an entire team of professionals who can provide customised guidance in understanding whether a fund is pass-through or taxed at the fund level. They will ensure that you avail of all the benefits and manage the tax implications effectively. Connect with us right away and diversify your portfolio by investing in AIFs while ensuring full compliance.
Note: This guide is for informational purposes only. The views expressed in this guide are personal and do not constitute the views of Savetaxs. Savetaxs or the author will not be responsible for any direct or indirect loss incurred by the reader for taking any decision based on the information or the contents. It is advisable to consult either a CA, CS, CPA, or a professional tax expert from the Savetaxs team, as they are familiar with the current regulations and help you make accurate decisions and maintain accuracy throughout the whole process.
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