What are Alternative Investment Funds? Understanding SEBI's AIF categories, new GARUDA framework

Understanding SEBI’s AIF Categories

SEBI classifies Alternative Investment Funds (AIFs) into three broad categories—Category I, Category II and Category III—based on their investment strategy, use of leverage, taxation and regulatory framework.

The category determines where a fund can invest, whether it can use leverage, the tax treatment it receives and the compliance requirements it must follow.

• Category I AIFs focus on sectors that have a positive economic or social impact. These include Venture Capital Funds (VCFs), SME Funds, Social Venture Funds, Infrastructure Funds and the newly introduced Angel Funds. These funds typically invest in startups, small businesses, infrastructure projects and socially driven enterprises. Portfolio-level leverage is not permitted, although limited operational borrowing is allowed. Category I funds enjoy pass-through taxation under Section 115UB, meaning income is taxed in the hands of investors rather than at the fund level. They also receive certain regulatory concessions and are eligible for investments from institutions such as pension and gratuity funds.
• Category II AIFs are the broadest and most widely used category. They invest in private equity, listed equities (subject to limits), structured credit, real estate and other alternative assets. Like Category I, they cannot use leverage beyond operational needs and also benefit from pass-through tax treatment. Because of their flexibility, Category II funds are the preferred choice for many private equity, venture debt and credit fund managers.
• Category III AIFs cater to sophisticated investment strategies involving leverage and active trading. These funds may invest across asset classes, trade in derivatives and deploy hedge fund-like strategies. Unlike the first two categories, Category III AIFs are taxed at the fund level at the maximum marginal rate for individuals. They are also subject to higher regulatory oversight because of their use of leverage and more complex investment approaches.

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What changes under SEBI’s GARUDA framework?

Against this backdrop, SEBI’s new Green-Channel: AIF Rollout Upon Document Acknowledgement (GARUDA) framework seeks to simplify and accelerate the process of launching AIF schemes without compromising regulatory oversight.

Under the revised process, regular AIF schemes can commence operations 10 working days after filing their Private Placement Memorandum (PPM) through SEBI’s Intermediary (SI) Portal. Earlier, fund managers had to wait for SEBI to review the PPM before launching a scheme, often resulting in longer timelines.

However, SEBI clarified that an AIF’s first scheme can be launched only after the fund has received registration or after the 10-working-day period from filing the application, whichever is later.

Despite the faster approval process, SEBI has retained the role of Merchant Bankers in ensuring regulatory compliance. Before a PPM is filed, the Merchant Banker must independently verify that all disclosures are accurate, complete and compliant with applicable regulations.

GARUDA Framework: Key Changes

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The banker must also submit a due diligence certificate along with declarations relating to the AIF, its sponsor, manager, minimum continuing interest commitment and PAN details. To maintain independence, the Merchant Banker cannot be associated with the AIF, its sponsor, manager or trustee.

The regulator has, however, eased norms for Accredited Investor-only (AI-only) Funds, Large Value Funds (LVFs) and Angel Funds. AI-only Funds and LVFs are no longer required to route their PPMs through a Merchant Banker or wait for SEBI’s observations. They can launch schemes immediately after filing the PPM, provided the AIF is already registered. Angel Funds have also been exempted from the Merchant Banker filing requirement.

SEBI has additionally introduced a naming convention requiring schemes exclusively for accredited investors to include “AI Only Fund” or “AIOF”, while Large Value Funds must use “LVF” in their names. The GARUDA framework applies to all AIF scheme PPMs filed after the notification of the SEBI (Alternative Investment Funds) (Second Amendment) Regulations, 2026.

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