By Himanshu Mandavia, Partner, Price Waterhouse & Co LLP
The alternative investment fund (AIF) regime in India has witnessed a remarkable ascent, underpinned by the burgeoning availability of domestic capital and the continued support of prominent Indian institutional investors. In parallel, the unified investment structure, wherein a feeder vehicle aggregates overseas capital in jurisdictions such as Mauritius before channeling investments into an India AIF, has rapidly emerged as the preferred paradigm for cross-border fund flows.
Despite this momentum, the regulatory and tax landscape governing AIFs remains in a state of dynamic evolution, with the Securities and Exchange Board of India (SEBI) issuing frequent circulars and the tax authorities providing evolving interpretations on critical provisions. The interplay of recent legislative amendments, regulatory pronouncements and nuanced interpretations under the Income Tax Act and Foreign Exchange Management Act (FEMA) necessitates a proactive and agile approach by fund managers to ensure robust compliance and optimal structuring.
Key tax developments: new Income Tax Act 2025
A pivotal development in the tax regime is the notification of the New Income Tax Act 2025, which was enacted by Parliament in August 2025 and is slated to come into effect from 1 April 2026. Notably, a key amendment, retained in the new legislation, pertains to the classification of securities held by Category I and II AIFs as “capital assets” through statutory definition. As a result, any transfer of such securities by these AIFs is subject to capital gains taxation, affording significant clarity and predictability in transaction structuring and negotiations, including the drafting of share purchase agreements. This legislative certainty hopefully may also extend to additional returns received by AIF sponsors, supporting its characterisation as capital gains.
From a transactional perspective, the AIF structure confers several strategic advantages. For instance, in the context of exits, buyers are not obligated to withhold tax on payments made to AIFs, thereby streamlining negotiations and mitigating the need for extensive tax indemnities. Furthermore, distributions up the investment chain to foreign investors are insulated from indirect transfer taxation, enhancing the attractiveness of the AIF structure for global capital.
On the indirect tax front, the treatment of carried interest has attracted some amount of scrutiny under the Goods and Services Tax (GST) framework. While the Supreme Court has previously rejected the tax authorities’ claims under the service tax regime, ongoing inquiries under the GST law persist. Although the capital gains characterisation under the income tax law does not automatically extend to GST interpretations, it nonetheless could provide some persuasive support for the position that such distributions should not be classified as service income.
Heightened SEBI oversight and governance
As far as SEBI regulations are concerned, a significant development – as encapsulated in SEBI’s Master Circular of October 2024 – is the imposition of a heightened duty of care on AIF managers and key managerial personnel (KMP). They are now expressly required to conduct rigorous due diligence on both investors and investee entities, ensuring that the AIF structure does not inadvertently facilitate regulatory or legal non-compliance. This expectation is particularly salient when structuring new funds, as any aggressive or “sharp” interpretations may be scrutinised for potential regulatory arbitrage.
Additionally, SEBI’s Circular of December 2024 introduces a restriction whereby investors, other than sponsors and managers, are precluded from receiving disproportionate returns. In scenarios where additional returns are to be shared with employees of the manager, it’s imperative to assess whether mechanisms such as employee benefit trusts fall within the permitted exceptions, or whether such distributions must be routed exclusively through the sponsor or manager.
SEBI has also instituted an overhaul of the investment portfolio valuation framework, mandating the adoption of standardised methodologies, especially for securities already governed by the SEBI (Mutual Funds) Regulations. Along with amendments that stipulate mandatory engagement of independent valuers, these should enhance overall transparency and bolster investor confidence.
From a FEMA standpoint, a critical consideration in transaction structuring is the classification of AIFs as either foreign-owned and controlled or Indian-owned and controlled, based on the ultimate ownership and control of sponsors and managers. This classification triggers a cascade of compliance obligations, including adherence to foreign investment guidelines, sectoral caps, valuation norms, and reporting requirements. The challenge is particularly pronounced when a foreign-owned and controlled AIF undertakes secondary purchases or sales, as such transactions must be executed strictly at fair value to comply with both FEMA and tax law valuation requirements.
While the regulatory and tax framework for AIFs in India may seem intricate, it’s evolving toward greater clarity and investor protection. For fund managers and sponsors, this complexity is not a deterrent but an opportunity to differentiate through robust governance, transparent structuring and proactive compliance. Those who embrace these changes will not only mitigate risk but also unlock significant value in a market poised for sustained growth.
As the landscape continues to shift, staying ahead requires more than awareness, it demands action. Engage with experienced advisors, review your fund structures, and ensure alignment with the latest SEBI and tax guidelines.
Note: The views expressed by the author are personal.
About the author
Himanshu Mandavia is a Partner in the Deals team of Price Waterhouse & Co LLP in India and has more than 25 years of experience in tax consulting. He focuses on transaction structuring, covering a wide range of complex tax and regulatory matters relevant to venture capital and private equity funds. He has extensive experience on both buy- and sell-side transactions involving due diligence and transaction structuring as well as advising on fund set-up aspects. Himanshu has been a speaker at various professional forums in India and the U.S., such as IVCA, Wall Street Tax Association, USIBC, AICPA, TiE, and has authored several articles in leading economic and tax publications.
