AIF categories decoded: how Category I, II and III differ and why SEBI sets a Rs 1 crore entry floor
SEBI's AIF rules sort every fund into three categories with different leverage, tenure and tax treatment, yet Regulation 10(c) applies the same Rs 1 crore entry floor to all three.
India's Alternative Investment Fund industry runs on a three-way split written into a single sub-regulation. Regulation 3(4) of the SEBI (Alternative Investment Funds) Regulations, 2012, last amended on 19 November 2025, requires every AIF to register in one of three categories. The category it registers under decides what it may buy, whether it may borrow, how long its investors stay locked in, and who pays the tax on what it earns.
The entry price barely moves between them. Regulation 10(c) bars an AIF in any category from accepting an investment worth less than Rs 1 crore from an investor, and Regulation 10(f) caps a scheme at 1,000 investors. That combination is why an AIF scheme looks nothing like a mutual fund scheme with lakhs of unit holders, and why the category labels matter so much to the few who clear the floor.
Side-by-Side Comparison
Regulation 3(4) defines the three buckets by what the fund does, not by how it is constituted. Category I covers funds investing in start-up or early stage ventures, social ventures, SMEs, infrastructure, or other sectors the government or regulators consider socially or economically desirable; the clause names venture capital funds, SME funds, angel funds, social impact funds, infrastructure funds and special situation funds. Angel funds were written into that list with effect from 9 September 2025.
Category II is defined by exclusion. Regulation 3(4)(b) covers any AIF that falls in neither Category I nor Category III and does not undertake leverage or borrowing beyond what is permitted; its explanation names private equity and debt funds as the typical residents. Category III is the only bucket defined by technique: Regulation 3(4)(c) covers funds employing diverse or complex trading strategies that may employ leverage, including through listed or unlisted derivatives, and its explanation names hedge funds and funds trading with a view to making short-term returns.
| Feature | Category I | Category II | Category III |
|---|---|---|---|
| Typical funds | Venture capital, SME, angel, social impact, infrastructure, special situation | Private equity, debt funds | Hedge-style, long-short, complex strategies |
| Defining test (Reg 3(4)) | Sector the government or regulators treat as desirable | Residual: not Cat I, not Cat III, no leverage beyond permitted | Diverse or complex trading strategies; may use leverage |
| Leverage for investment | Not permitted (Reg 16(1)(c)) | Not permitted (Reg 17(c)) | Permitted with investor consent (Reg 18(c)) |
| Temporary borrowing | Max 30 days, 4 times a year, 10% of investable funds | Max 30 days, 4 times a year, 10% of investable funds | Governed by the Reg 18(c) leverage limit |
| Structure (Reg 13) | Close ended, minimum 3-year tenure | Close ended, minimum 3-year tenure | Open ended or close ended |
| Concentration cap (Reg 15) | 25% of investable funds per investee company | 25% of investable funds per investee company | 10% per investee company |
| Manager or sponsor skin in the game (Reg 10(d)) | 2.5% of corpus or Rs 5 crore, whichever is lower | 2.5% of corpus or Rs 5 crore, whichever is lower | 5% of corpus or Rs 10 crore, whichever is lower |
Two rows do most of the work. The first is leverage. Regulation 16(1)(c) tells a Category I fund it shall not borrow directly or indirectly, or engage in any leverage for making investments or otherwise, with one narrow exception: borrowing for temporary funding and day-to-day operational needs, for at most 30 days, on at most four occasions a year, and for at most 10% of investable funds. Regulation 17(c) applies the identical test to Category II.
Category III gets the opposite treatment. Regulation 18(c) lets such a fund borrow or use leverage with investor consent and within a limit SEBI specifies, provided it periodically discloses to investors and to the Board its overall leverage, the leverage from cash borrowing, the leverage from derivatives or complex products, and its main source of leverage. Regulation 18(a) also lets it hold derivatives, units of other AIFs and structured products, and Regulation 18(ab), inserted with effect from 9 January 2023, lets it trade credit default swaps.
The second row is tenure. Regulation 13(1) makes Category I and Category II funds close ended with the tenure fixed at the time of application, and Regulation 13(2) sets a minimum tenure of three years. Regulation 13(3) allows schemes of a Category III fund to be open ended or close ended. Regulation 13(5) permits a close-ended fund to extend its tenure by up to two years with the approval of two-thirds of unit holders by value of their investment.
The Rs 1 Crore Floor and What It Buys
Regulation 10(c) is one sentence: the AIF shall not accept from an investor an investment of value less than Rs 1 crore. It applies to all three categories identically, and unlike the PMS threshold of Rs 50 lakh it has not been indexed since the regulations were notified in 2012. Three provisos carve out narrow exceptions.
| Investor or fund type | Minimum investment | Basis |
|---|---|---|
| Any investor, any category | Rs 1 crore | Regulation 10(c) |
| Employee or director of the AIF, or of the Manager | Rs 25 lakh | First proviso to Regulation 10(c) |
| Accredited investor | Floor does not apply | Second proviso to Regulation 10(c) |
| Individual in a social impact fund investing only in securities of not-for-profit organisations registered or listed on a social stock exchange | Rs 2 lakh | Third proviso to Regulation 10(c) |
The floor does not stand alone. Regulation 10(b) requires each scheme to hold a corpus of at least Rs 20 crore, dropping to Rs 5 crore for a social impact fund scheme, and Regulation 10(g) bars an AIF from soliciting funds except by private placement, which is why these funds cannot advertise as a mutual fund can.
Even the exit is priced in crores. Regulation 14(1) allows units of a close-ended AIF to be listed, but only subject to a minimum tradable lot of Rs 1 crore, and Regulation 14(2) permits listing only after the final close. A listed unit is therefore no liquidity route for anyone below the floor.
Regulation 10(d) sets the manager's own exposure: a continuing interest of not less than 2.5% of corpus or Rs 5 crore, whichever is lower, rising under the proviso to 5% of corpus or Rs 10 crore for Category III. That interest shall not be through the waiver of management fees, which closes the obvious workaround.
Concentration limits differ sharply. Regulation 15(1)(c) caps a Category I or II fund at 25% of investable funds in one investee company; Regulation 15(1)(d) caps Category III at 10%. For large value funds for accredited investors those ceilings rise to 50% and 20%, the clearest signal of how SEBI grades investor sophistication inside one regulation.
Tax Treatment
The Income-tax Act, 2025 came into force on 1 April 2026 and now governs the tax year 2026-27. Section 224 of that Act deals with tax on the income of an investment fund and its unit holders, and it carries forward the pass-through scheme that Category I and Category II AIFs registered with SEBI have enjoyed for years. Income arising to a unit holder from investments made in the fund is chargeable in that unit holder's hands as if the investment had been made directly.
Two mechanics inside Section 224 matter to unit holders. Income accruing to the fund during a tax year but not paid or credited to the unit holder is deemed credited on the last day of that year, in the proportion that unit holder was entitled to. And the character of the income is preserved in transit, so capital gains arrive as capital gains and interest as interest, rather than being reclassified into a single distribution head.
Category III sits outside that regime. It is not an investment fund for pass-through purposes, so its income is generally taxed at the fund level and the unit holder receives a post-tax distribution. Two investors with identical gross returns can therefore end up with very different net outcomes on the strength of the category label alone.
| Item | Category I and II | Category III |
|---|---|---|
| Taxing point | Unit holder (pass-through, Section 224) | Generally the fund |
| Business income | Taxed at the fund level | Taxed at the fund level |
| Character of income | Preserved in the unit holder's hands | Absorbed at the fund level |
| Undistributed income | Deemed credited on the last day of the tax year | Not applicable in the same form |
Where gains do reach the investor as capital gains, the Budget 2024 rates apply. Long-term capital gains on equity are taxed at 12.5% with an annual exemption of Rs 1,25,000, and short-term capital gains on equity at 20%, both effective from 23 July 2024. Those are the same rates that apply to a directly held share, which is the point of a pass-through: see the LTCG and STCG entries for how the holding-period test works.
Because Category I and II funds are close ended with a minimum three-year tenure under Regulation 13(2), cash flows are lumpy and a single annualised figure flatters or understates what happened. The XIRR calculator handles irregular drawdowns and distributions, and the AIF returns calculator models the fee and carry drag between gross and net.
Who Should Pick Which
Nothing below is investment advice, and Oquilia is not a registered investment adviser. What follows is a description of the investor profile each category was drafted around, read off the regulations themselves.
Category I is structurally an illiquidity trade. Regulation 13(2) locks capital for at least three years, Regulation 13(5) allows a further two-year extension on a two-thirds vote by value, and Regulation 16(1)(c) forbids leverage, so returns must come from the underlying ventures rather than borrowed money. The 25% single-company cap in Regulation 15(1)(c) lets a fund run a concentrated book, which cuts both ways.
Category II carries the same lock-in and leverage ban, but Regulation 17(a), substituted with effect from 23 May 2025, points it at unlisted securities and at listed debt securities, including securitised debt instruments, rated 'A' or below by a credit rating agency registered with SEBI. That rating range is explicit in the regulation, and it places the credit risk below the investment-grade centre of the market.
Category III is the only category whose risk can be amplified beyond the capital committed, because Regulation 18(c) permits leverage with investor consent. The offsetting protections are the tighter 10% concentration cap in Regulation 15(1)(d), the higher 5%-or-Rs-10-crore manager commitment in the proviso to Regulation 10(d), and the periodic leverage disclosures that Regulation 18(c) requires be made to investors and to the Board.
A common misreading is that Category III's ability to be open ended under Regulation 13(3) makes it liquid. It removes the fixed tenure; it does not create a redemption right. Regulation 18(d) expressly contemplates SEBI directing restrictions on redemption, alongside conduct-of-business and prudential requirements.
For readers below the Rs 1 crore floor, the comparison that matters is with products that carry no such gate. Our explainer on the Rs 50 lakh PMS gate covers the next rung down, and SEBI's 2026 mutual fund re-categorization covers the buckets with no minimum at all. A SIP or lumpsum route stays open below Rs 1 crore; Regulation 10(c) closes the AIF route entirely.
FAQ
What is the minimum investment in an AIF?
Regulation 10(c) of the SEBI (Alternative Investment Funds) Regulations, 2012 sets the floor at Rs 1 crore per investor across all three categories. The first proviso lowers it to Rs 25 lakh for employees or directors of the AIF or of its Manager; the second disapplies the floor for an accredited investor.
What is the difference between Category I, II and III AIFs?
Category I invests in sectors the government or regulators treat as socially or economically desirable: venture capital, SME, angel, social impact, infrastructure and special situation funds. Category II is the residual bucket for private equity and debt funds that do not use leverage. Category III employs complex trading strategies and may use leverage under Regulation 18(c).
Can an AIF borrow money to invest?
Category I and Category II cannot. Regulations 16(1)(c) and 17(c) permit borrowing only for temporary funding and day-to-day operational needs, for at most 30 days, on at most four occasions a year, and for at most 10% of investable funds. Category III may use leverage under Regulation 18(c) with investor consent and within the limit SEBI specifies, and must disclose its level and source periodically.
How long is money locked up in an AIF?
Regulation 13(1) requires Category I and II funds to be close ended and Regulation 13(2) sets a minimum tenure of three years, extendable by up to two years under Regulation 13(5) with the approval of two-thirds of unit holders by value. Schemes of a Category III fund may be open ended or close ended under Regulation 13(3).
How are Category I and II AIFs taxed compared with Category III?
Category I and II AIFs registered with SEBI have pass-through status under Section 224 of the Income-tax Act, 2025, in force since 1 April 2026: income is chargeable in the unit holder's hands as if the investment had been made directly, with its character preserved. Category III income is generally taxed at the fund level, so unit holders receive a post-tax distribution.
How many investors can an AIF scheme have?
Regulation 10(f) caps a scheme at 1,000 investors, excluding accredited investors from that count. Regulation 10(b) separately requires a corpus of at least Rs 20 crore per scheme, reduced to Rs 5 crore for a social impact fund scheme, and Regulation 10(g) restricts fundraising to private placement.