AIF for NRIs: how alternative investment funds work
An Alternative Investment Fund (AIF) is a privately pooled vehicle under the SEBI (Alternative Investment Funds) Regulations, 2012 — the regulatory home of venture capital, private equity, private credit and hedge-fund-style strategies in India. Entry is set at ₹1 crore per investor, and NRIs can hold AIF units under FEMA on a repatriable or non-repatriable basis depending on the funding route. The single most important thing to understand is the category, because the category decides how — and where — the fund's income is taxed.
The three categories
| Category | What it invests in | Structure | How it's taxed |
|---|---|---|---|
| Category I | Venture capital, SME, social-impact, infrastructure and special-situation funds — areas the government treats as economically desirable. | Close-ended, minimum tenure 3 years; capital drawn down via calls. | Pass-through (Section 115UB) — taxed in your hands. |
| Category II | Private equity and private credit/debt funds — the residual category, with only operational leverage permitted. | Close-ended, minimum tenure 3 years; drawdown structure. | Pass-through (Section 115UB) — taxed in your hands. |
| Category III | Complex or diverse trading strategies — long-short, derivatives, leverage; the hedge-fund category. | May be open-ended or close-ended. | At the fund level — no pass-through; you receive post-tax amounts. |
Pass-through: Category I & II
Under Section 115UB, a Category I or II AIF is fiscally transparent for everything except business income: interest, dividends and capital gains earned by the fund are exempt in the fund's hands and taxed in yours, with the same character — as if you had made the underlying investment directly. A long-term gain on listed equity inside the fund reaches you as a long-term gain, taxed at the current 12.5% beyond the Section 112A exemption; short-term listed-equity gains at 20%; interest at your applicable rate. Business income, by contrast, is taxed at the fund level. Each year the fund issues Form 64C — the income-by-character statement that goes into your ITR.
For NRIs, the fund deducts TDS under Section 194LBB — at the rates in force rather than the flat 10% residents see, which makes the deduction treaty-eligible: with a TRC and Form 10F in place before distribution, applicable DTAA positions can be applied at source. Because pass-through preserves the character of income, the treaty analysis follows the underlying — gains on shares sit under the shares clause, interest and dividends under their rate-cap articles (see the DTAA explainer) — which is genuinely professional-advice territory rather than a rule of thumb. And note the TDS is not necessarily the final tax; the true liability settles through your return.
Fund-level: Category III
Category III AIFs have no pass-through status: the fund itself pays tax on its income, typically at the highest applicable rates, and investors receive post-tax amounts. The ITR side is simpler — there's no income-by-character statement to reconcile — but the flip side is that treaty relief generally has nothing to attach to at the investor level, since the tax was never yours to begin with. (Specified Category III funds set up in the GIFT City IFSC operate under their own exemption regime.)
Illustrative only · Not investment, tax or legal advice. Rates for FY 2025–26 excluding surcharge/cess; loss pass-through and TDS outcomes depend on conditions under Section 115UB and your facts. Wealth North is a mutual fund distributor and distributes PMS/AIF products; it does not provide investment advice. Consult a qualified professional for your situation.