SEBI issues framework for retention of proceeds and ‘Inoperative Fund’ status for AIFs

The Securities and Exchange Board of India (SEBI) has notified the Securities and Exchange Board of India (Alternative Investment Funds) (Amendment) Regulations, 2026 (Amendment Regulations) on April 16, 2026, which insert a new Sub-Regulation 29(10A), enabling an Alternative Investment Fund (AIF) to be tagged as an ‘inoperative fund’ in such manner and subject to such conditions as may be specified by SEBI from time to time and amend Regulation 29(7) to provide that distribution of liquidation proceeds to investors, after satisfying all liabilities, will be “subject to conditions as may be specified by the Board from time to time.”

Separately, SEBI has also amended the minimum investment threshold for Social Impact Funds under Regulation 10(c), substituting “two lakh” with “one thousand”, thereby reducing the minimum value of investment by individual investors in Social Impact Funds to INR 1,000.

The amendments are in line with the measures approved by SEBI at its 213^th meeting held on March 23, 2026 (which can be accessed here).

To operationalise the new flexibility around winding up and surrender of registration, SEBI has issued a circular dated June 16, 2026 (Circular) addressed to all AIFs and all Venture Capital Funds (VCFs) registered under the erstwhile Securities and Exchange Board of India (Venture Capital Funds) Regulations, 1996.  The Circular sets out the conditions and modalities for: (i) retention of proceeds beyond the permissible fund life; (ii) tagging of AIFs/VCFs as ‘inoperative funds’; and (iii) the regulatory framework applicable to such inoperative funds.

Key highlights of the Amendment Regulations and the Circular are outlined below:

1. Retention of proceeds beyond permissible fund life:

The Circular permits AIFs and schemes of AIFs to retain liquidation proceeds beyond the liquidation or dissolution period (collectively, the Permissible Fund Life) if at least one of the following conditions is met:

• • There is demonstrable receipt by the AIF or its scheme of an official written communication indicating a potential tax, regulatory or legal liability.  This includes communications from tax authorities, regulatory authorities, law enforcement agencies, courts of law or investors / counterparties in relation to litigation, and covers show-cause notices, re-assessment notices, investigation summons and similar communications, and is not limited to crystallized demand notices.

• • The manager proposes to retain proceeds on account of anticipated (possible or probable) litigation or tax demands and has obtained consent from at least 75% of investors by value of their investment in the relevant scheme.  The manager must, at the time of seeking consent, disclose to investors: (I) the quantum proposed to be retained; and (II) the estimated time period for which such proceeds are proposed to be retained.

• • The amounts proposed to be retained are for meeting residual winding‑up related operational expenses, substantiated through invoices, supporting documents or records of comparable expenses incurred in previous years. For such residual expenses, the retention period is capped at three years from the end of the Permissible Fund Life of the AIF/scheme.  The Standard Setting Forum of AIFs (SFA), in consultation with SEBI, is yet to frame implementation standards to standardise the operational expense heads under which monies may be retained.

All monies retained in accordance with the above conditions must be invested in line with Regulation 15(1)(f) of the Securities and Exchange Board of India (Alternative Investment Funds) Regulations, 2012 (AIF Regulations) (i.e., permissible temporary investments).

Once the relevant liabilities have been discharged and all retained monies have been distributed to investors, the scheme is to be wound up in accordance with Regulation 29 of the AIF Regulations.

2. Application for ‘inoperative fund’ status:

The Circular provides a mechanism for AIFs to be formally tagged as ‘inoperative funds’ where only limited post‑winding‑up activities remain.

• • AIFs having one or more schemes with retained monies under the Circular (i.e., meeting one or more of the conditions in paragraph 3 of the Circular and discussed above) and seeking to surrender registration may apply for ‘inoperative fund’ status.

• • AIFs whose schemes have not retained any monies beyond the Permissible Fund Life but wish to continue with registration solely in anticipation of a favourable outcome of pending litigation may also apply for ‘inoperative fund’ status.

• • Applications must be made in the format set out in Annexure A to the Circular and have to be submitted by way of e-mail through the e-mail address specified by SEBI in the Circular.

• • Annexure A must be accompanied by: (I) an undertaking from the manager confirming completeness and accuracy of the information, completion of investment activity and liquidation of all assets, grounds and documentation for retention, commitment not to launch new schemes or charge management fees post tagging, observance of Regulation 15(f) for investment of retained monies, annual reporting until liabilities are resolved and a NIL bank balance is achieved, and distribution of residual proceeds (including those arising from favourable litigation outcomes) in accordance with the private placement memorandum (PPM); and (II) an undertaking from the trustee / board of directors / designated partners (as applicable) confirming that they have reviewed the circumstances, consider the application bona fide and that retained amounts (if any) are solely for the grounds specified.

• • Upon SEBI’s approval of the application, the AIF is tagged as an ‘inoperative fund.’  Such an inoperative fund may apply for surrender of its certificate of registration only after all liabilities are discharged and retained monies have been distributed across all its schemes.

3. Regulatory framework for inoperative funds: 

From the date an AIF is tagged as an Inoperative Fund, the following conditions apply:

• • Monies retained by schemes in terms of the Circular must continue to be invested in accordance with Regulation 15(1)(f) of the AIF Regulations.

• • The AIF is prohibited from launching any new schemes and no management fees may be charged in respect of any of its schemes.

• • Annexure B to the Circular sets out regulatory requirements that cease to apply to inoperative funds and the effective dates of such non‑applicability.  These inter-alia include:

• • • Limited Quarterly Activity Report and Annual Activity Report under Chapter 21 of the SEBI Master Circular for AIFs dated June 03, 2026 (AIF Master Circular), with exemptions applying from the quarter following the quarter in which the AIF is tagged inoperative (for quarterly reports) and the financial year following the financial year in which the AIF is tagged inoperative (for annual reports).

• • • audit of PPM terms under paragraph 21.3 of Chapter 21 of the AIF Master Circular, from the financial year following the year of tagging;

• • • intimations of changes in the PPM under paragraph 21.4 of Chapter 21 of the AIF Master Circular;

• • • reporting of information (including scheme wise valuation and cash flow data) to benchmarking agencies for performance benchmarking under Chapter 22 of the AIF Master Circular;

• • • requirement to appoint a custodian for safekeeping of securities under Regulation 20(11) of the AIF Regulations, from the date of obtaining inoperative fund status;

• • • periodic disclosures to investors regarding fund investments under Regulation 22(a) of the AIF Regulations, from the date of obtaining inoperative fund status; and

• • • annual (Category I and II AIFs) / quarterly (Category III AIFs) investor reports under Regulations 22(g) and 22(h) of the AIF Regulations, from the financial year/quarter subsequent to the year/quarter in which the AIF is tagged inoperative.

• • • With respect to valuation under Regulations 23(2) and 23(3), from the date of obtaining inoperative fund status, valuations must be reported to investors as part of the annual retention status report and the updated Net Asset Value (NAV) of the AIF units must be reported to depositories within 30 calendar days from the end of March of every financial year.

• • AIFs with schemes that have retained monies and AIFs tagged as inoperative funds must submit an Annual Retention Status Report to SEBI (through the SEBI Intermediary Portal) and to investors of the relevant schemes in the format prescribed in Annexure C to the Circular, within 30 calendar days from the end of March of every financial year.

4. Extension of framework to erstwhile Venture Capital Funds: The Circular clarifies that the facility for retention of proceeds beyond permissible fund life and availing Inoperative Fund status also applies to Venture Capital Funds registered under the erstwhile SEBI (Venture Capital Funds) Regulations, 1996.

Conclusion:

Through these amendments, SEBI has put in place a structured regime for AIFs and erstwhile VCFs to retain proceeds beyond the permissible fund life for clearly delineated purposes, and to transition to an ‘inoperative fund’ status with significantly reduced ongoing compliance obligations, subject to safeguards on investments of retained monies and mandatory annual reporting.