Alternative Investment Funds – Meaning, Types and Tax Benefits

alternative investment fund: Are you one of those investors looking for options beyond traditional investments such as mutual funds, stocks, cash or bonds? If so, Alternative Investment Funds (AIFs) may be the right investment option for you. This is because these investment options can provide higher returns compared to traditional investments.

There are over 900 registered AIFs in India with a total value of Rs. According to SEBI, it is $8.3 trillion as of March 31, 2023.

But what exactly are alternative investment funds and how is taxation achieved in such funds? Read on to get all the answers and learn more about it!

alternative investment fund

What is an alternative investment fund?

Alternative investment funds are different from traditional investments and refer to private pooled investment funds that invest in alternative asset classes such as hedge funds, private equity, venture capital, real estate, commodities and other investment types.

In India, the minimum ticket size to invest in AIF is Rs. 1 crore, the minimum investment amount for directors, employees and fund managers is Rs. 25 lakh. An AIF can be set up as a company or a limited liability partnership (LLP).

AIFs (generally) carry higher risk compared to stocks, but offer diversification, higher returns and access to asset classes not easily available through traditional investments.

These funds are quite popular with experienced investors willing to take on higher risks to potentially earn higher returns.

Generally, high net worth individuals (HNIs) and institutions invest in AIFs as the investment amount is significantly higher. However, there are expectations that these funds will become accessible to mid-sized individual investors in the future as well.

What are the types of Alternative Investment Funds (AIFs)?

Understanding AIFs is easier if you know the categories of AIFs as per SEBI.

Category I: Invests primarily in start-ups, early-stage ventures, small and medium-sized enterprises, or other government-run sectors. or regulators deem it economically and socially viable.

Category II: Includes alternative investment funds such as private equity or bond funds. They do not use leverage or borrowing other than to cover day-to-day operating expenses.

Category III: AIF or other open-end funds that utilize complex or diverse transactions, such as hedge funds, PIPE funds, or target short-term funds to generate short-term returns. You can utilize leverage by investing in listed/unlisted derivatives.

Who can invest in AIF?

• Indian residents, NRIs and foreigners can invest.
• Co-investors such as the investor’s spouse, parents, or children are allowed.
• The minimum investment limit is 1 million won. 1 billion to investors, Rs. 25 lakh for employees, directors and fund managers.
• Most AIFs have a minimum lock-in period of three years.
• The maximum number of investors per scheme is limited to 1,000, with a maximum of 49 for angel funds.
• AIFs must be registered under the SEBI (Alternative Investment Funds) Rules, 2012.

What are the tax benefits of AIF?

Taxation of AIF varies depending on its category.

Categories I and II have passing status. This means that any income or loss (other than business income) generated by an AIF is taxable in the hands of the investor. Simply put, capital gains tax applies to any profits or losses incurred by the fund.

For Category III, the income earned, whether capital gains or business income, is taxable in the hands of the AIF at the fund level. If you invest, the investor receives the return after this deduction.

Have you invested or have you ever invested in alternative investment funds?

Written by Shivani Singh

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