AIF Category 2

What Is AIF Category 2

AIF Category 2 refers to funds that invest in assets that are not listed under Category 1 or Category 3. These include private equity funds, debt funds, real estate funds, distressed asset funds and other strategy driven vehicles that are not allowed to use leverage except for temporary needs.

These funds aim to generate stable long term returns through structured, negotiated deals that are not available in public markets.

Key Features of AIF Category 2

1. Wide Range of Strategies

AIF Category 2 funds can follow multiple investment approaches. Common strategies include:

• Private equity
• Real estate
• Structured credit
• Special situation funds
• Distressed asset funds
• Debt based funds with negotiated terms

2. No Leverage for Speculation

The fund cannot borrow money to amplify returns. Borrowing is allowed only for temporary needs like:

• Meeting operational expenses
• Fulfilling redemption requests
• Managing cash flow mismatches

3. Higher Transparency

Investors receive periodic updates on:

• Portfolio performance
• NAV disclosures
• Underlying securities
• Exit timelines

Minimum Investment Required

SEBI regulations specify that the minimum amount to invest in AIF Category 2 is:

• INR 1 crore for most investors
• INR 25 lakh for employees and directors of the fund manager
• INR 5 crore minimum corpus for each fund
• No maximum limit on fund size

AIFs are meant for sophisticated investors who understand risk, long lock-in periods and illiquid assets.

Lock-In and Liquidity

AIF Category 2 funds come with a fixed tenure, normally:

• 4 to 8 years, depending on the strategy
• Option to extend by up to 2 years with investor approval

You cannot freely redeem your investment like mutual funds. Exits depend on:

• Asset sale
• Buyback
• Listing (rare)
• Secondary transfers

How Returns are Generated?

Returns depend on the fund strategy. For example:

• Private equity funds create value by investing in growing companies at negotiated valuations.
• Debt funds earn interest income.
• Real estate funds invest in projects at early stages and exit when value appreciates.

Investors may earn:

• Capital appreciation
• Interest income
• Profit share (carried interest)

Taxation of AIF Category 2

Taxation is one of the major reasons investors choose Category 2.

1. Pass-Through Status

Category 2 has pass-through status only for non business income.

This means the tax liability passes directly to investors.

Investors pay tax depending on the income type:

• Capital gains are taxed as per holding period
• Interest income is taxed as regular income
• Business income is taxed at the fund level

2. Capital Gains

• Long term capital gains on listed equity: 10 percent above INR 1 lakh
• Long term capital gains on non equity assets: 20 percent with indexation
• Short term capital gains: taxed as per slab

3. TDS Applicability

Funds deduct TDS before distributing returns to investors.

Regulations Governing AIF Category 2

AIF Category 2 funds operate under SEBI’s Alternative Investment Fund Regulations, 2012. Key rules include:

• Mandatory registration with SEBI
• Clear disclosure of strategy, risk, fees and sector limits
• Auditor certification and annual reporting
• No guaranteed returns allowed
• No leverage except temporarily
• Sponsor or manager contribution of at least 2.5 percent of corpus or INR 5 crore, whichever is lower

These rules ensure transparency and investor protection.

Who Should Invest in AIF Category 2

You may consider this category if you are:

• A high net worth investor
• Comfortable with illiquidity
• Looking for diversification beyond public markets
• Seeking higher returns through negotiated deals and structured opportunities
• Willing to stay invested for many years

Benefits of AIF Category 2

• Access to private markets
• Professional fund management
• Strong diversification
• Potential for higher returns
• Structured deals that are not available to retail investors
• Regulated by SEBI

Risks You Should Consider

• Long lock in
• Limited liquidity
• Market, credit and operational risks
• Performance depends heavily on fund manager skill
• Not suitable for short term investors

Conclusion

AIF Category 2 is one of the most flexible and popular categories under SEBI’s AIF framework. It offers access to private markets, structured deals and long term growth opportunities. While the minimum investment and risks are higher than regular products, experienced investors often use Category 2 to diversify their portfolio and capture returns that public markets cannot offer.

If you are planning to invest, it is important to understand the strategy, risk profile, lock in period and taxation before making a decision.

FAQs on AIF Category 2

1. What is AIF Category 2 in simple words

It is a fund that invests in private equity, real estate, debt or special situations to generate long term returns.

2. Can retail investors invest

No. Only eligible investors with high financial understanding can invest.

3. What is the minimum investment

INR 1 crore for general investors.

4. What is the typical tenure

Between 4 to 8 years.

5. Is it safe to invest

It is regulated but carries higher risk than traditional instruments.

6. How are returns taxed

Capital gains are taxed as per individual slabs and holding periods. Non business income has pass through taxation.

7. Can I exit early

Only through a secondary transfer or if the fund provides an exit opportunity.