AIF Category I vs II vs III: Which Structure Actually Fits Your Fund?

Key Takeaways:

• Category I is not just a VC label, it covers SME funds, social impact funds, and infrastructure funds, each with distinct concessions from SEBI and a hard prohibition on leverage at the portfolio level.
• Category II is the right starting point for most first-time managers because it covers the widest investment universe with no sector restrictions, no government approval requirements, and no asset class exclusions.
• Category III is the only category that can use leverage (up to 2x NAV), run as an open-ended fund, and invest through complex derivatives but it comes with double the sponsor commitment requirement and fund-level taxation.
• From May 2025, NISM runs two separate certification tracks – Series-XIX-D for Category I and II managers, and Series-XIX-E for Category III meaning your category choice now determines which exam your team needs to clear.
• The Large Value Fund (LVF) classification, available across all three categories, now requires a minimum per-investor commitment of ₹25 crore (reduced from ₹70 crore under SEBI’s Third Amendment, November 2025) and unlocks a materially lighter compliance burden for funds with accredited-only investor bases.
• GIFT IFSC operates under an entirely separate framework (IFSCA Fund Management Regulations, 2025) the three FME tiers do not map cleanly to SEBI’s three categories, which creates genuine optionality for cross-border fund design but also complexity that domestic-only managers often underestimate.

Why the category you pick shapes everything downstream

The AIF category is not a filing formality. It determines what you can invest in, whether you can use leverage, how your investors are taxed, how much of your own capital you must commit, whether your fund can stay open-ended, what certification your team must hold, and how intensively SEBI will oversee your ongoing operations.

Most of these are not things you can adjust later. A category change requires fresh registration with SEBI – existing schemes cannot migrate – so managers who pick the wrong box often find themselves locked into constraints that were avoidable with a clearer upfront decision.

The three categories are defined by exclusion as much as by inclusion. Category I is for funds SEBI considers to have demonstrable positive economic spillovers – venture capital, SMEs, infrastructure, social ventures. Category III is for funds using leverage, derivatives, and complex trading strategies. Category II is everything in between: any fund that does not fit Category I or III and does not use leverage beyond day-to-day operational needs. That residual design is precisely what makes Category II so widely used. It is not a second-best option – it is deliberately broad.

Tax treatment is where the asymmetry is most consequential. Category I and II both carry income-tax pass-through status under Section 115UB of the Income Tax Act, 1961 – income flows through to investors and is taxed in their hands at their applicable rates. Category III is taxed at the fund level at the maximum marginal rate for individuals. That single difference routinely reshapes how LP economics are presented and negotiated, and it is often the deciding factor for managers whose investor base sits in the highest personal tax brackets.

Category I: what the concessions are actually worth

Category I has four recognised sub-types:

1. Venture Capital Funds (VCFs) – unlisted securities of start-ups and early-stage companies.
2. SME Funds – small and medium enterprises as defined under the relevant government notification.
3. Social Venture Funds (SVFs) – enterprises with social objectives, often with returns capped or reinvested.
4. Infrastructure Funds – infrastructure projects and companies, typically with long capital deployment cycles.

Angel funds are now a standalone Category I sub-type in their own right, following the Second Amendment Regulations notified in September 2025. The earlier minimum corpus requirement of ₹5 crore has been removed. Angel funds must now onboard at least five accredited investors before declaring a first close, which must happen within 12 months of SEBI taking the PPM on record.

What SEBI actually concedes to Category I funds.

The concessions are real, but narrower than most managers assume:

• Provident funds, superannuation funds, and gratuity funds – otherwise restricted from alternative investment exposure – may invest up to 5% of their investible surplus in specified Category I AIFs, per the March 2021 notification. For managers who want domestic institutional anchors from the PF universe, this matters a great deal.
• SEBI’s PPM review tends to move faster for Category I applications where the mandate is unambiguous – a VCF that invests exclusively in DPIIT-recognised start-ups is a cleaner filing than a PE fund with a mixed mandate.
• Government fund-of-fund vehicles – including SIDBI’s Fund of Funds for Startups – commit only to Category I VCFs. If a government or DFI anchor is part of your fundraising plan, Category I is not optional.

The leverage prohibition is absolute.

Category I funds cannot borrow at the portfolio level. Operational borrowing – to manage drawdown timing, for example – is capped at 30 days and cannot happen more than four times in a year. This is not a soft guideline; it is a hard constraint. Managers whose thesis involves any gearing on portfolio positions – even modest – cannot use Category I, regardless of how development-oriented their mandate appears.

Who should actually be in Category I.

The managers for whom Category I genuinely earns its place are those who need either the PF-investor access or the government co-investment channel – and whose portfolio will not, under any scenario, require leverage. A VC fund raising from corporate PF trusts or targeting SIDBI anchor capital is the natural Category I candidate. A manager who simply runs early-stage deals but has no particular need for those concessions will often find Category II gives the same investment flexibility without the sub-type constraint on their mandate.

Category II: why it is the right default and when it stops being one

Category II is the correct starting point for most first-time managers, and this is not a hedged position. The definition is deliberately broad – it captures every fund that is not Category I or Category III and does not deploy leverage beyond operational requirements. In practice, a Category II fund can invest across:

• Unlisted equity and equity-linked instruments (private equity, growth capital, convertible instruments)
• Listed equity (subject to concentration limits – no single investee company above 10% of investible funds, per SEBI’s 2026 clarification)
• Private and structured credit, mezzanine debt, non-convertible debentures
• Real estate, directly or through SPVs
• Distressed assets
• Pre-IPO securities

There are no SEBI-prescribed sector restrictions, no government approval requirements for specific asset types, and no exclusions beyond what a Category I manager already faces. The neutral SEBI posture – no specific incentives, but also no prohibitions beyond the baseline – is an advantage for managers who want maximum optionality without the operational complexity of a leveraged or derivative-driven mandate.

The closed-ended requirement is non-negotiable.

Every Category II fund must be close-ended. SEBI does not prescribe a maximum tenure, but the review process expects tenure to be proportionate to the asset class – PE and credit funds typically run 5+2 or 6+2 year cycles. For strategies that depend on liquidity (quick-flip listed equity, for example), Category II is not the right fit regardless of leverage appetite.

Custodian is mandatory from day one.

As of 2024, every Category II fund must appoint a custodian from scheme launch – the earlier ₹500 crore corpus trigger no longer applies. Factor this into your pre-launch timeline and budget; custodian onboarding is not instant.
From 1 April 2026, all AIF units must be held in dematerialised form. This applies across all categories and affects both new and existing schemes. Factor demat account setup for LPs into your pre-launch onboarding checklist.

Sponsor commitment.

The manager or sponsor must maintain a minimum continuing interest of 2.5% of the fund corpus or ₹5 crore, whichever is lower – in cash, not through a management fee waiver. For a ₹200 crore fund, that is a ₹5 crore personal or promoter commitment at closing. First-time managers routinely underestimate how long it takes to have this capital ready.

Category II stops being the right answer when your strategy requires leverage, when your LPs need open-ended liquidity, or when your portfolio is explicitly derivatives-driven. Those requirements pull you firmly into Category III.

Category III: what you gain, and what it costs

Category III covers hedge funds, long-short equity, absolute-return mandates, PIPE funds, and any vehicle that uses derivatives and leverage as core instruments – not incidentally.

Leverage is permitted, up to 2x NAV.

This is the defining characteristic of Category III and the reason managers choose it. Leverage can be taken through borrowing, derivatives, or both. The quantum must be disclosed in the PPM. SEBI requires strategy-level exposure reports within seven calendar days and a dedicated compliance officer with derivative accounting capability. The operational overhead of running a leveraged fund is meaningfully higher than Category I or II – not impossible, but it needs to be built into the fund’s expense model from the outset.

Open-ended or close-ended – both are available.

Category III is the only AIF category that can be open-ended. Redemption windows are typically monthly or quarterly, with gating clauses that allow the manager to suspend withdrawals during exceptional volatility. For strategies investing in listed securities where LP liquidity is a selling point, this matters enormously.

Higher sponsor commitment.

The manager or sponsor must maintain a minimum continuing interest of 5% of the corpus or ₹10 crore, whichever is lower – double the Category I and II requirement. For a ₹200 crore fund, that is a ₹10 crore commitment. Build this into your fund economics before your first LP conversation.

Fund-level taxation is the trade-off.

Category III is taxed at the fund level at the maximum marginal rate applicable to individuals. Investors receive post-tax distributions. This makes the after-tax return profile less attractive for domestic HNIs in high tax brackets compared to Category I and II pass-through treatment. Managers running Category III funds need to present LP economics on a post-tax basis and ensure that the strategy’s gross returns justify the additional tax drag.

Who cannot participate as an LP.

Banks are not permitted to invest in Category III AIFs as LPs – the restriction applies at the entity level. NBFCs can invest, subject to a 10% per-scheme cap and the 20% system-level exposure limit under the RBI’s NBFC Directions, 2025. This effectively closes a large segment of the domestic institutional capital base to Category III managers.

Differences between Category AIF I, AIF II & AIF III

Table: Category I vs II vs III – key parameters

Parameter	Category I	Category II	Category III
Investment universe	Start-ups, SMEs, infra, social ventures	Unlisted equity, PE, credit, real estate, pre-IPO, listed equity	Listed equities, derivatives, all asset classes (leveraged)
Leverage	Not permitted (operational only – 30 days, max 4x/year)	Not permitted (same operational exception)	Permitted – up to 2x NAV
Fund tenure	Close-ended	Close-ended	Open-ended or close-ended
Sponsor commitment	2.5% or ₹5 crore (lower of two)	2.5% or ₹5 crore (lower of two)	5% or ₹10 crore (lower of two)
Minimum LP ticket	₹1 crore (₹25 lakh for employees/directors)	₹1 crore (₹25 lakh for employees/directors)	₹1 crore (₹25 lakh for employees/directors)
Minimum corpus	₹20 crore (₹5 crore for angel funds)	₹20 crore	₹20 crore
Investor cap per scheme	1,000 (uncapped for accredited-only schemes)	1,000 (uncapped for accredited-only schemes)	1,000
Tax treatment	Pass-through (Section 115UB, IT Act 1961)	Pass-through (Section 115UB, IT Act 1961)	Fund-level – maximum marginal rate
NISM track (from May 2025)	Series-XIX-D	Series-XIX-D	Series-XIX-C or Series-XIX-E
Bank LPs permitted	Yes (subject to RBI exposure limits)	Yes (subject to RBI exposure limits)	No (except minimum sponsor contribution via bank subsidiary)
SEBI registration fee	₹5 lakh	₹10 lakh	₹15 lakh

What the NISM certification split actually means for your team

Until April 2025, all AIF managers operated under a single certification standard – NISM Series-XIX-C, introduced in January 2024, which covered all three categories. From 1 May 2025, NISM launched two new examinations:

NISM Series-XIX-D covers Category I and II – investment valuation, fund governance for unleveraged close-ended vehicles, and the tax pass-through framework.

NISM Series-XIX-E covers Category III – leverage mechanics, derivative accounting, open-ended governance, and the higher disclosure and exposure-reporting requirements unique to the category.

SEBI formalised this split in its June 2025 notification (No. F. No. SEBI/LAD-NRO/GN/2025/249, dated 25 June 2025) under Regulation 4(g)(i) of the AIF Regulations. The requirement: at least one key investment team member must hold a valid NISM certification corresponding to the fund’s category.

The original Series-XIX-C remains valid across all three categories. It is not being phased out. A team member who holds XIX-C satisfies the requirement for Category I, II, and III funds. XIX-D and XIX-E are additional options, not mandatory replacements.

Where managers get caught out. If you are building a Category III team from professionals who have cleared Series-XIX-D (the Category I and II track), your team is not in compliance at launch. At least one team member needs XIX-C or XIX-E. This is a hiring timeline issue, not a post-launch fix, and it is worth resolving before the PPM goes to SEBI.

How the GIFT IFSC option fits into this choice

Funds set up in GIFT City’s International Financial Services Centre fall under the International Financial Services Centres Authority (IFSCA) – not SEBI. The IFSCA Fund Management Regulations, 2025 govern these funds, and SEBI’s three-category framework does not apply to them.

IFSCA registers Fund Management Entities (FMEs) under three tiers. Each tier can launch schemes that are functionally similar to one or more of the domestic AIF categories:

Table: GIFT City FME tiers and their closest domestic equivalent

IFSCA FME Tier	Investor profile	Closest domestic AIF equivalent	Minimum FME net worth
Authorised FME	Accredited investors or commitments above USD 250,000; start-up and early-stage focus via Venture Capital Schemes	Category I (VCF)	USD 75,000
Registered FME (Non-Retail)	Institutional and HNI investors; broad mandate including PE, credit, and trading strategies	Category II and Category III	Per FM Regulations
Registered FME (Retail)	Retail investors	Not typically used for AIF-equivalent mandates	Higher than Non-Retail

This mapping is approximate, not exact. The IFSCA framework does not impose the same leverage prohibition on Category II-equivalent schemes that SEBI does domestically – one of the main reasons Category III-type strategies have moved aggressively to GIFT City. As of June 2025, GIFT City reported cumulative commitments of USD 22.11 billion, with Category III-equivalent schemes accounting for USD 10.15 billion across 166 restricted schemes.

Tax treatment at GIFT City mirrors domestic categories broadly.

Category I and II equivalent funds retain income-tax pass-through status under Section 115UB of the IT Act, 1961. Category III equivalent funds are taxed at the fund level but benefit from a 100% tax holiday on business income, claimable for 10 consecutive years within the first 15 years of operation. Non-resident investors in Category I and II equivalent GIFT City funds are exempt from filing Indian income tax returns provided tax is deducted on distributions, and are not required to obtain a PAN.

Custodian requirements diverge between GIFT City and domestic.

For GIFT City funds, custodian appointment is mandatory for Category III equivalent funds from inception. For Category I and II equivalents, it applies only when the corpus exceeds USD 70 million – a material cost difference compared to domestic Category II funds, where the custodian is mandatory from day one regardless of corpus.

For managers evaluating a GIFT City vehicle alongside a domestic AIF, our AIF Setup service covers both SEBI registration and IFSCA FME registration. The interaction between FEMA’s Overseas Portfolio Investment framework, RBI’s Liberalised Remittance Scheme limits, and the IFSCA fee table creates enough cross-border complexity that it warrants separate treatment from the domestic category decision.

The Large Value Fund layer – and what the 2025 threshold change means

A Large Value Fund for Accredited Investors (LVF) is not a fourth AIF category. It is a classification that sits on top of any Category I, II, or III scheme where every non-promoter investor is an accredited investor and commits above the prescribed minimum per scheme.

Under SEBI’s Third Amendment Regulations, gazetted 18 November 2025, the minimum per-investor commitment for LVF classification was cut from ₹70 crore to ₹25 crore. The reduction followed recommendations from SEBI’s Alternative Investment Policy Advisory Committee (AIPAC) and was driven by a specific constraint: insurance companies, one of the most important sources of domestic institutional capital, had internal diversification limits that made ₹70 crore per-fund commitments commercially impractical. The new ₹25 crore threshold brings them into the eligible base.

What LVF status actually unlocks:

• LVFs can launch under intimation to SEBI rather than going through the full merchant-banker PPM filing and SEBI comment cycle. For managers with a clean, institutionally-led LP base, this compresses the pre-launch timeline meaningfully.
• LVF schemes are exempt from the standard SEBI-prescribed PPM template and the mandatory annual PPM audit.
• The 1,000-investor-per-scheme cap does not apply to accredited-investor-only schemes, allowing LVFs to scale beyond that ceiling.
• Accredited investors in LVF schemes are not subject to the 25% single-company concentration cap that governs standard AIF schemes – relevant for managers running concentrated portfolios.

The same Third Amendment also formally introduced “Accredited Investors only fund” (AI-only fund) as a distinct sub-type, with LVFs now sitting inside that broader definition. Existing AIF schemes can convert to LVF status subject to positive consent from all existing investors – the conversion mechanics were detailed in SEBI’s circular of 8 December 2025.

LVF classification does not change which category you register under. But for managers who know from the outset that every LP will be an accredited investor committing ₹25 crore or more, it is worth designing the fund as an LVF from launch rather than retrofitting it later.

Five scenarios where the category choice is clear

Scenario 1: Seed and early-stage VC fund, targeting SIDBI co-investment and PF anchor capital.

Category I (VCF sub-type) is the only viable option. SIDBI’s Fund of Funds for Startups commits exclusively to SEBI-registered VCFs. The PF-investment relaxation – 5% of investible surplus, per the March 2021 notification – is available only for specified Category I AIFs, not Category II. The leverage prohibition is not a constraint for a fund that invests in equity of early-stage companies.

Scenario 2: First-time PE manager, investing in growth-stage unlisted companies and structured credit, raising ₹200-500 crore from family offices and HNIs.

Category II is the right choice. It covers the full mandate without sector restrictions. The 2.5%/₹5 crore sponsor commitment is manageable. Pass-through tax treatment means LPs are taxed on actual returns at their personal rate – more defensible in LP conversations than fund-level taxation. The closed-ended lifecycle aligns with the 5+2 or 6+2 year cycle typical for PE and credit.

Scenario 3: Established manager running a long-short equity strategy, deploying into listed securities, using equity derivatives, needing quarterly redemptions for LPs.

Category III is the only viable option. The leverage and derivatives requirement disqualifies Category I and II. The open-ended format enables quarterly redemptions. The higher sponsor commitment (5%/₹10 crore) and fund-level taxation need to be built into fund economics from the start. At least one team member must hold NISM Series-XIX-C or XIX-E.

Scenario 4: Family office deploying into real estate and infrastructure across India and offshore, with USD-denominated LPs.

For the domestic sleeve, Category II handles real estate and infrastructure without any category-specific restrictions. For the offshore sleeve, an IFSCA Registered Non-Retail FME at GIFT City feeding into the domestic Category II can offer meaningful tax advantages for non-resident LPs – particularly on TDS on distributions and PAN exemption. This is a dual-domicile setup and requires coordinated advice on both the SEBI AIF framework and the IFSCA FM Regulations 2025.

Scenario 5: Infrastructure debt manager targeting pension and insurance LP commitments, 12-year tenor, no equity upside.

The decision here is genuinely context-dependent. Category I (Infrastructure Fund sub-type) makes sense if the LP base requires that designation for internal investment committee approval – some pension funds and insurance mandates specify it. Category II works equally well for investment purposes and gives more mandate flexibility if the portfolio blends infrastructure debt with other credit. In Treelife’s experience, this choice is driven more by what the anchor LP’s investment committee will approve than by any intrinsic difference in what the two categories permit.

When Category I and Category II both work – how to actually decide

For managers whose strategy qualifies for Category I, this question comes up in nearly every Treelife engagement. The AIF framework does not compel you to register under Category I simply because your mandate fits a Category I sub-type. A VC fund can register under Category II with no legal restriction.

Three factors drive the decision in practice:

LP eligibility. If any anchor LP is a provident fund, superannuation fund, or government-backed entity that requires Category I classification for internal approval, Category I is not a choice – it is a requirement. There is no workaround.

Government and DFI access. If SIDBI FFS, NaBFID, or similar entities are in your fundraising pipeline, Category I is required. These vehicles have mandate-level restrictions that preclude Category II funds from receiving commitments.

Portfolio flexibility. A manager whose portfolio might include growth-stage companies alongside early-stage, or who wants to hold credit alongside equity, will be better served by Category II. SEBI’s PPM review expects alignment with the Category I sub-type mandate – a VCF that quietly holds growth equity and structured credit will attract queries. Category II removes that constraint without sacrificing any material LP access.

Practitioner note – Priya Kapasi, Associate Partner, Treelife

In the AIF setup engagements we run at Treelife, the category decision is rarely the hard part. Most managers arrive with a clear enough sense of strategy. What catches people is the downstream detail that the category choice triggers.

For Category II, the most frequent oversight we see is treating the sponsor commitment as a closing formality. Under Regulation 10(d) of the AIF Regulations, the 2.5%/₹5 crore continuing interest must be a cash commitment – it cannot come from a management fee waiver. For a manager raising a ₹200 crore fund, that is ₹5 crore in personal or promoter capital that needs to be available at closing. We see first-time managers who have secured the LP capital but have not prepared their own balance sheet for this. The resulting delay is avoidable with three months of advance planning.

For Category III, the compliance infrastructure is consistently underestimated. The exposure reports (within seven calendar days), the daily NAV disclosure obligation, and the dedicated compliance officer requirement are not items to figure out post-launch. A manager who builds fund economics on a lean team will encounter problems at the first SEBI review cycle. We build the compliance cost into the fund expense model from day one of the engagement.

The NISM split since May 2025 also creates a timing risk that often surfaces late. If a Category III manager is building their team from professionals who hold Series-XIX-D (the Category I and II track), they are not in compliance at the point of launch. At least one team member needs XIX-C or XIX-E. We flag this in the hiring plan, not in the PPM review.

If you are at the category decision stage, our AIF Setup service covers the full journey – category and fund design, SEBI or IFSCA filing, PPM review, and post-launch compliance. Engagements start with a 45-minute scoping call with me or Rohit Gandhi (Senior Associate, Finance) to map your mandate, LP base, and team to the right category before any filing work begins.