How to Set Up an Alternative Investment Fund (AIF) in India

There are a lot more fund managers and family offices looking at India’s private capital market now, and a lot of that focus is on one question: how do you actually set one up and get it running?

An alternative investment fund (AIF) is a regulated vehicle for pooling money from multiple investors and investing in private equity, start-ups, real estate, structured credit or complex trading strategies outside the mutual fund framework. This guide explains what an AIF is, why it is attractive to fund managers and investors, how it is taxed and what it takes to set up one in India.

What Is an Alternative Investment Fund (AIF)

An alternative investment fund is a private pooled investment vehicle, regulated by the Securities and Exchange Board of India (SEBI) under the SEBI (Alternative Investment Funds) Regulations, 2012. An AIF is not open to the general public, unlike mutual funds. The target group is high-net-worth individuals, family offices and institutional investors who can commit larger sums and are willing to accept longer lock-in periods.

AIFs can be in the form of a trust, a company, a limited liability partnership or a body corporate. By far the most common structure in India is a trust, with a sponsor setting up the fund, a trustee holding it in a fiduciary capacity and an investment manager making day-to-day decisions.

Why Fund Managers and Investors Choose AIFs

Flexibility is the key to the appeal. A mutual fund is subject to strict diversification rules and generally only invests in publicly traded securities. Portfolio Management Services (PMS) are more customised but still within a fairly narrow band. An AIF can invest in almost anything depending on the category under which it registers, be it unlisted equity, distressed debt, infrastructure projects, real estate or derivatives-heavy trading strategies.

For investors, that flexibility often means access to opportunities that are not available in public markets and a structure where the fund manager’s interests are aligned with theirs via a mandatory co-investment. For fund managers, the AIF provides a regulated, scalable vehicle for building a track record and raising successive fund rounds, rather than managing money via informal or one-off arrangements.

The Three Categories of AIF

SEBI classifies all AIFs into three categories. The category determines what you can invest in and how the fund is taxed.

• Category I is for funds targeting startups, small and medium-sized enterprises, social enterprises and infrastructure. Such funds are considered to have a positive economic or social impact, and hence certain regulatory concessions are given to them. Pension and gratuity funds are permitted to invest in them.
• Category II is the broadest category, which includes private equity funds, debt funds and fund-of-funds not classified under Category I or III. Borrowing at the portfolio level is prohibited, but limited operational borrowing is permitted.
• Category III funds engage in diverse and complex trading strategies, including the use of derivatives and short-term trading. Such funds are allowed to borrow within the limits set by SEBI and are taxed differently from the other two categories.

How an AIF Gets Taxed: Understanding Section 115UB

Tax treatment is one of the more misunderstood parts of this process, and it’s worth understanding before you pick a category.

Category I and Category II AIFs can get the benefit of pass-through taxation under Section 115UB of the Income Tax Act. Most of the income the fund earns is not taxed at the fund level, as it is a pass-through structure. Instead, it passes through to investors who report and pay tax on it individually, avoiding double taxation. This pass-through regime was introduced by the Finance Act, 2015, and further clarified by an amendment in 2025 that securities held by these funds are capital assets and gains from the sale of the securities are treated as capital gains and not business income. If the fund itself earns any business income, that income is still taxed at the fund level before it is distributed.

Category III AIFs are different. These funds do not get pass-through treatment. Instead, the fund itself pays tax on its income before distributing returns to investors, who then receive post-tax proceeds. The difference is significant when you’re deciding on a category, as it could affect the fund’s tax planning and how appealing the structure is to potential investors.

Step-by-Step: How to Set Up an Alternative Investment Fund

Once you understand the categories and tax implications, you then follow a defined sequence to set it up.

• Select your category and legal structure: Decide whether your investment strategy is Category I, II or III, and choose a trust, LLP or company structure to house it.
• Confirm eligibility: Every AIF scheme requires a minimum corpus of Rs. 20 crore (Rs. 5 crore for angel funds), a minimum investor commitment of Rs. 1 crore per investor, and a continuing interest of the sponsor or manager of at least 2.5 per cent of the corpus or Rs. 5 crore, whichever is lower.
• Design fund economics: Specify the management fee, carried interest, hurdle rate and distribution waterfall that will dictate how returns are split.
• Write the core documents: This includes the Private Placement Memorandum, Trust Deed, Contribution Agreement and Investment Management Agreement.
• File Form A with SEBI: Submit your application along with supporting documents on the fund’s strategy, key personnel and risk management systems through the SEBI Intermediary Portal.
• Address SEBI observations: Most applications receive questions around governance issues, fee structure, or investor protections. Deal with these directly to avoid delays.
• Get Registration Certificate & open for First Close: Once approved, onboard investors, run AML and KYC checks, and make your first capital call.

A private limited or LLP fund vehicle can generally be incorporated in a few weeks, but the full path from strategy discussion to SEBI registration typically runs three to six months depending on how complete and clean the initial filing is.

Documents You’ll Need

Along with the main fund documents listed above, have these at hand:

• Fit and proper declarations for sponsor and manager about financial soundness and regulatory history
• Track record and experience of the key investment team
• A clearly defined investment strategy for the PPM
• Application and payment of registration fee in terms of SEBI fee schedule

Applications do not get stuck for months instead of weeks for any reason other than incomplete documentation.

Common Questions Before You Register a Fund

First-time sponsors will often ask whether an informal investment club or family office arrangement can be converted into a registered AIF. The answer is generally a yes, but it implies starting the process of documentation and structuring from scratch, for informal arrangements never meet SEBI’s governance and disclosure standards.

Another frequent question is if foreign investors can participate. They can, through the automatic or approval route, depending on the sector the fund invests in, but this adds FEMA compliance and reporting requirements that need to be built into the structure from day 1 rather than added later.

How The Startup Gig Helps With AIF Setup

At The Startup Gig, the AIF Setup practice offers fund structuring, documentation, and the SEBI registration process as one integrated engagement rather than separate tasks handed to different advisors. Category selection, fee design, PPM drafting and the SEBI application itself are all handled by the same team, which matters as a decision taken during structuring often reappears during documentation and registration.

For fund managers considering whether to register their first fund, having that continuity from the first strategy call through to the registration certificate tends to head off the gaps that surface later, during a capital call or an investor dispute, when they’re much more expensive to fix.

Final Thoughts

Deciding to set one up is a structural decision that determines how your fund functions for years. Your tax treatment, pool of investors, and regulatory obligations all depend on the category you choose. Getting the eligibility thresholds, documentation, and SEBI filing right the first time saves months of rework and builds the kind of institutional credibility that serious investors look for before they commit capital.

Frequently Asked Questions