Understanding Category 2 AIFs in 2026: Meaning, Types, 2026 Tax Rules, & Investment Conditions

Introduction

After mutual funds, PMS got popular among investors in India. But, again, the major change was the increase in the investment limit to ₹50 lakhs, making it more HNI specific. 

But the major focus of PMS was still listed securities. It invested in stocks, bonds, and liquid instruments. 

And that’s where, a need of new financial product – Alternative Investment Fund (AIF) was launched in 2012, that focused on both private equity and listed securities.  

Stay with us to explore what is category 2 AIF, where does it invest, structure of this AIF, tax rules of Cat 2 AIF, and much more. 

This is all-in-one guide for all your AIF doubts!

What is Cat 2 AIF?

Category 2 AIF is a type of AIF fund (prescibed by SEBI) that invests in private equity and debt funds. 

It does not fall under Category I or III, nor is allowed to undertake leverage or borrowing.

Cat II AIFs primarily invest in unlisted/listed equity or debt securities (including securitized debt instruments) rated 'A' or below by a SEBI-registered credit rating agency. 

Examples: Where Does Cat 2 AIF Invest?

While Category 2 AIF is more inclined towards private equity, here’s where HNIs can invest:

Private Equity Funds:

Later-stage investments in established companies for growth or buyouts.

Debt Funds: 

Investments in debt securities of companies, including distressed debt, mezzanine financing, and real estate debt.

Funds of Funds (FoF):

When an AIF fund decides to invest in another AIF, it is called FoF. They can invest in a collection of mutual funds, ETFs, or any other funds.

Special Situation Funds: 

Focused on stressed assets, refinancing, or insolvency resolution (if not classified under Cat I).

Structured Credit Funds:

They invest in non-traditional, customized debt instruments.

Real Estate Funds:

where the fund invests into commercial and residential real estate or infrastructure projects that have rental yields.

Key Features and Structure of Cat 2 AIF

Unlike any AIF, even here, the minimum investment limit for AIF Cat 2 is ₹1 crore for investor. But, apart from that, there are other features as well, such as;

• Close-ended Structure: Cat II AIFs is a close-ended, with a minimum tenure of three years for each scheme.
• No Public Offer: Funds are raised only through private placement, not public offerings.
• Minimum Corpus: Each scheme must have a minimum corpus of INR 20 crore.
• Minimum Investment: Each investor shall commit at least ₹1 crore. ₹25 lakh for employees/directors of the fund or manager itself.
• Maximum Investors: No more than 1,000 investors per scheme.
• Others:
  • May engage in hedging subject to guidelines.
  • Cat 2 AIF may buy or sell credit default swaps in terms of the conditions.

(Note: For Special Situation Funds (SSF), AIF Cat 2 shall accept an investment of value not less than ₹10 crore rupees from an investor. Accredited investor will attract ₹5 crore not less.)

Eligibility: Who Can Invest In Category 2 AIF?

Here’s who can invest in Cat 2 AIF:

High Net Worth Individuals (HNIs):

Individuals with an investment corpus of ₹1 crore.

Moderate to high risk investors: 

Those willing to stay invested for 5–7 years or more can find this AIF comfortable.

Institutional Investors: 

Ideal option for Ultra HNIs, family offices, and accredited investors with large investment corpus.

NRIs: 

Even Non-Resident Indians (NRIs) can invest in Cat II AIFs under the automatic or approval route, subject to sectoral caps and FDI policy.

Key Rules & Regulations for Category II AIFs

As per Securities and Exchange Board of India guidelines, Category II AIFs must follow certain investment, reporting, and operational regulations. Here are some of the important rules investors should know:

(Note: The co-investment terms cannot be more favourable than those offered to the AIF itself.)

How to Invest in Cat 2 AIF?

In India, investing in Cat 2 AIF happens through research available funds through financial advisors, distributors, or directly from fund managers.

But, here’s a short step-by-step guide on how to invest in Cat 2 AIF:

Step 1: Identify Cat 2 AIF Funds Available in the Market

Research available Cat II AIFs usually available through financial advisors, distributors, or directly from fund managers.

Step 2: Review PPM

This document details the fund's investment strategy, risks, fees, governance, and terms. It is mandatory for all Cat II AIFs to provide a PPM to prospective investors. 

Read and check it carefully. 

Step 3: Complete KYC & Sign Agreements

Submit identity and financial documents, along with signature on Contribution Agreement and fund documents.

Step 4: Capital Commitment

Transfer funds as per capital calls. For AIF Category 2 fund, the minimum corpus required is ₹1 crore (and ₹25 lakh for employees/directors). 

For large value funds for accredited investors, the minimum is INR 70 crore. 

Step 5: Ongoing Monitoring

Receive reports from the fund manager on regular basis. Likewise, also attend meetings (if any) to understand changes in the NAV (Net Asset Value).

Step 6: Exit

At the end of the fund's tenure, proceeds from investments are distributed to investors (as per the distribution waterfall in the fund documents).

Taxation of Category 2 AIF in 2026

If you live in India, and invest in Cat 2 AIF, here’s how much tax you’ll pay in 2026:

• Pass-through Status:
  • Cat II AIFs enjoy tax pass-through status for income (other than business income), meaning such income is taxed in the hands of investors, not at the fund level.
  • Business income is taxed at the fund level at the maximum marginal rate (if not a company/firm).

(Note: Losses (other than business loss) from Cat 2 AIF can be passed through to investors if units are held for at least 12 months.)

Cat 1 AIF vs Cat 2 AIF: Key Differences

The key difference between Cat 1 AIF vs Cat 2 AIF is the universe of investment and the borrowing capacity.

Final Thoughts

Category II AIFs can be a good option for investors looking to explore investment opportunities beyond traditional options like stocks or mutual funds. From private equity to debt and real estate, they offer access to alternative assets with long-term growth potential.

That said, these funds are usually better suited for investors with a higher risk profile and a long-term mindset. 

Before investing, it’s important to understand the fund strategy, risks, lock-in period, and overall investment objective to see if a Category II AIF aligns with your financial goals.