Key takeaways
- Minimum ticket ₹1 crore (₹25 lakh for the manager's employees and directors).
- No pass-through: the fund pays tax; trading income at the maximum marginal rate.
- Compare post-tax, post-fee returns with PMS and mutual funds before investing.
Quick answer: minimum investment is ₹1 crore per investor (₹25 lakh for employees and directors of the fund or its manager). The fund, not the investor, pays tax on its income: capital gains at capital-gains rates and trading (business) income at the maximum marginal rate. Distributions to investors are generally not taxed again.
What a Category III AIF is
SEBI’s AIF Regulations put funds that use diverse or complex trading strategies, and may use leverage, including through listed or unlisted derivatives, in Category III. In practice that means long-short equity funds, absolute-return and hedge strategies, and some PIPE (private investment in public equity) funds.
| Point | Category III rule |
|---|---|
| Minimum investment | ₹1 crore per investor per scheme; ₹25 lakh for employees and directors of the AIF or its manager |
| Minimum fund size | ₹20 crore per scheme |
| Structure | Usually a trust; open-ended or close-ended |
| Leverage | Allowed, within limits set by SEBI |
| Tax | At fund level (no pass-through) |
| TDS on payouts | The 10% TDS on investment-fund income applies to Category I and II funds, not Category III |
Separately, SEBI’s 2025 amendments created “Accredited Investors only” schemes, and cut the minimum ticket for large value funds for accredited investors from ₹70 crore to ₹25 crore. These follow their own rules.
How Category III is taxed
- No pass-through. The pass-through regime (section 224 of the Income-tax Act, 2025, earlier section 115UB) covers only Category I and II funds. A Category III trust is taxed through its trustee as a representative assessee.
- Capital gains on listed shares are taxed at the fund level at the normal rates: 20% for short-term gains and 12.5% for long-term gains, plus surcharge and cess.
- Trading and derivatives income is generally business income, taxed at the maximum marginal rate. With surcharge and cess, this is the most expensive part of a Category III fund’s tax bill.
- Determinate vs indeterminate trust: if investors’ shares are not determinate, the maximum marginal rate can apply to all income. A July 2025 Delhi High Court ruling held that a Category III trust is not indeterminate merely because investors are not named in the deed.
- In your hands: the fund has already paid tax, so distributions are generally not taxed again. Gains on redeeming or selling units need separate advice based on the fund’s structure; check the tax note in the placement memorandum.
Category III vs PMS vs mutual funds
| Category III AIF | PMS | Equity mutual fund | |
|---|---|---|---|
| Minimum | ₹1 crore | ₹50 lakh | No real minimum |
| Who pays tax | The fund | You, on every trade in your account | You, when you redeem |
| Derivatives and leverage | Allowed within SEBI limits | Limited | Limited (hedging) |
| Fees | Management fee plus performance fee, often above a hurdle | Management and/or performance fee | Expense ratio, capped by SEBI |
Because a Category III fund pays tax at the fund level, your post-tax return depends heavily on the strategy’s mix of short-term gains and trading income. Ask the manager for post-tax returns, not just pre-tax.
Who can invest
- Resident individuals, HUFs, companies, LLPs, trusts and family offices that meet the minimum and complete KYC.
- NRIs and OCIs can invest, on a repatriable or non-repatriable basis, subject to FEMA and the fund’s own terms. Because the fund pays Indian tax itself, NRIs may find it hard to use treaty benefits. A GIFT City fund can work better for money held abroad; see GIFT City fund vs SEBI AIF.
- Foreign investors can invest in AIF units under the automatic route, subject to SEBI’s eligibility requirements.
Before you sign
- Check the fund’s SEBI registration in SEBI’s list of registered AIFs.
- Read the private placement memorandum: strategy, leverage, lock-in, exit loads and the tax note.
- Understand the fee stack: management fee, performance fee, hurdle and high-water mark.
- Ask for net-of-tax, net-of-fee returns for past periods.
- If you are an NRI, check how you will repatriate the money and whether your country of residence taxes the distribution again.
Related: how all AIF categories are taxed, AIF categories explained and setting up an AIF with SEBI.
Sources
- EaseValue: Section 224, Income-tax Act 2025 (AIF pass-through)
- TDSMAN: TDS on income from investment fund, section 393 (old 194LBB)
- Legal500: SEBI amends the AIF Regulations (accredited investors, large value funds)
- SEBI board paper: proposals for accredited investors (Sep 2025)
Frequently asked questions
What is the minimum investment in a Category III AIF?
₹1 crore per investor per scheme. Employees and directors of the AIF or its manager can invest from ₹25 lakh. Separate rules apply to accredited-investor-only schemes.
How is a Category III AIF taxed in India?
At the fund level. Category III AIFs do not get pass-through status, so the fund (usually a trust, through its trustee) pays tax: capital gains at capital-gains rates and trading or derivatives income at the maximum marginal rate. Distributions to investors are generally not taxed again.
Is there TDS on Category III AIF distributions?
The 10% TDS on income distributed by investment funds applies to Category I and II AIFs. Category III funds pay tax themselves, so that TDS provision does not apply to their distributions.
Can NRIs invest in Category III AIFs?
Yes, subject to FEMA, KYC and the fund's terms, on a repatriable or non-repatriable basis. Because the fund pays Indian tax itself, NRIs may not be able to use treaty benefits, so a GIFT City fund is sometimes a better fit.
Category III AIF or PMS: which is more tax-efficient?
It depends on the strategy. In a PMS every trade is taxed in your hands; in a Category III AIF the fund pays tax, with trading income at the maximum marginal rate. Compare post-tax, post-fee returns for your tax bracket.
Please note: this guide is general information based on the rules as they stood on the review date above. Regulations and RBI/CBDT procedures change often — please get advice on your specific facts before acting.