SEBI Introduces Inoperative Fund Framework Due to Exit Challenges Faced by AIFs

The Securities and Exchange Board of India (SEBI) has proposed amendments to the AIF Regulations, 2012 to introduce an “inoperative fund” framework aimed at facilitating smoother exit for Alternative Investment Funds (AIFs). The issue arose as many AIFs, despite completing their tenure and liquidating investments, could not surrender registration due to retained funds for pending or anticipated litigation, tax liabilities, or operational expenses, thereby failing to meet the NIL balance requirement. SEBI proposed allowing such funds to retain proceeds under specified conditions, including demonstrable claims, 75% investor consent for anticipated liabilities, and substantiated operational expenses with a cap of three years. Inoperative funds will receive compliance relief but cannot launch new schemes or charge fees and must report annually. The proposal balances operational flexibility with investor protection and ensures a structured, transparent exit mechanism.

Securities and Exchange Board of India

Flexibility to AIFs in winding up of scheme and surrendering of registration

1. Objective:

1.1. This Board Memorandum proposes to amend the SEBI (Alternative Investment Funds) Regulations, 2012 (‘AIF Regulations’), to provide a predictable and efficient manner for exit to Alternative Investment Funds (‘AIFs’) who wish to discontinue their activities by introducing a framework for categorising such AIFs with no active fund management activity as ‘inoperative funds’, with proportionately reduced compliance obligations pending final surrender of registration.

2. Issues under consideration:

2.1. Regulation 29 of the AIF Regulations lays down norms for winding up of AIFs, which inter-alia provides that –

2.1.1. An AIF shall be wound up upon completion of the tenure of the AIF or all schemes launched thereunder, as specified in the placement memorandum.

2.1.2. Within the liquidation period (that is, the period of one year following the expiry of tenure or extended tenure of the fund), the assets shall be liquidated, and the proceeds accruing to investors in the AIF or the scheme of the AIF shall be distributed to them after satisfying all liabilities.

2.1.3. Upon winding up of the AIF, the certificate of registration shall be surrendered to SEBI.

2.2. Accordingly, SEBI receives and processes applications for surrender of registration from AIFs. As evidence of the distribution of liquidation proceeds in connection with surrender of registration, an applicant is required to submit, inter-alia, bank account statement of the fund reflecting NIL balance.

2.3. However, SEBI has been receiving applications for surrender of AIFs, wherein the investments are liquidated and proceeds are distributed to investors, while retaining a portion of the liquidation proceeds in the fund’s account. Upon examining such applications, it is observed that certain AIFs/schemes of AIFs continue to retain proceeds of liquidated assets beyond the liquidation period or dissolution period (‘permissible fund life’) mainly for the following reasons:

2.3.1. Amounts retained on account of pending litigation or tax demand;

2.3.2. Amounts retained on account of anticipation of litigation or tax demand; and

2.3.3. Amounts retained for meeting residual operational liabilities.

The data on the aforesaid cases where they have applied for surrender is given below:

2.4. Consequently, AIFs that have completed their tenure and liquidated their investments, but have retained funds for the aforementioned reasons are unable to satisfy the NIL bank balance requirement for surrendering their registration. Such applications are then returned to the applicant under the current practice.

2.5. It is also observed that certain AIFs do not carry out any active fund management activity and continue to exist solely on account of anticipation of a favourable resolution of pending litigation(s). SEBI has also received representations from the AIF industry requesting a reduction in the compliance burden on such funds.

2.6. The entry into the securities market by intermediaries is subject to specified eligibility criteria, with a clearly laid down framework. It is equally important that the regulatory framework governing exit, where an entity seeks to discontinue its activities, should be clear, predictable and operationally efficient.

2.7. Accordingly, it is imperative to provide a proper framework for AIFs/schemes to retain reserves in genuine circumstances, so as to allow them to exit the fund management activity without significant compliance burden. Considering that there are many AIFs which are nearing the end of their tenure in near future, addressing these winding up related issues of AIFs is an immediate priority. The proposals in the memorandum intend to provide adequate flexibility and clarity in the extant AIF regulatory framework to address these issues.

3. Proposed regulatory approach and specific scenarios for retention of proceeds by AIFs:

3.1. The regulatory framework for AIFs is agnostic to whether the fund is actively managed or not. Thus, even in scenarios where the funds/schemes are continuing to exist solely on account of pending litigations/tax demands or resolving operational liabilities, these funds are treated at par with active funds with respect to the fulfillment of compliance requirement. Considering that this leads to burden on the manager of these AIFs, they apply for surrender or registration, while retaining reserves for meeting the aforesaid obligations. However, acceptance of surrender of registration pending distribution of proceeds of liquidation may have post-facto implications, with investors possibly making a claim on the retained amount in future. Further, any proceeds pending after satisfying all the liabilities should rightfully be distributed to the investors of the fund.

3.2. However, in order to address the issue faced by AIF industry, it is proposed that such funds which are continuing solely on account of pending litigations/tax demands or resolving operational liabilities may be tagged as ‘inoperative funds’ when they apply for surrender of registration. These funds may be allowed to retain money for the purpose of meeting the liabilities and operating expenses as per the proposal in this note.

3.3. To ensure that this proposed flexibility is not misused by AIFs to retain proceeds beyond fund life, the ‘inoperative fund’ tagging may be provided only in certain specific scenarios which genuinely warrant such status. Such specific circumstances and the regulatory considerations relevant to each, are discussed below.

3.4. Scenario 1 – Amounts retained due to pending litigation or tax demand

3.4.1. AIFs may be subject to tax demands received from Income tax department or be a party to litigations with investors, investee companies etc. In cases involving ongoing litigations or subsisting tax demands where a notice has been received, AIFs and managers have expressed difficulties in managing ongoing compliance obligations and bearing the associated costs.

3.4.2. Since such litigations can be prolonged, AIFs have requested that they be permitted to surrender their registration while retaining the amounts in question. However, as noted earlier, distribution of proceeds after satisfaction of all liabilities and maintenance of a NIL bank balance is a prerequisite for surrender of registration under the extant framework.

3.4.3. Considering industry feedback, it is proposed that AIF schemes may be permitted to retain liquidation proceeds beyond the permissible fund life, where there is demonstrable receipt of a litigation notice or tax/ regulatory demand.

3.4.4. The demonstrable receipt may include any official written communication from a tax authority, regulatory authority, law enforcement agency or from an investor or counterparty in relation to litigation, which indicates potential tax or regulatory liability. This shall include show-cause notices, re-assessment notices, or similar communications and shall not be restricted to crystallised demand notices.

3.5. Scenario 2 – Amounts retained due to anticipated litigation or tax demand

3.5.1. It is observed that certain AIFs retain monies beyond the permissible fund life in anticipation of litigation or tax demands. Since such anticipated liabilities are based on assumptions rather than demonstrable claims, permitting retention beyond the permissible fund life necessitates appropriate safeguards to protect investor interests.

3.5.2. In this regard, it may be noted that the PPM template under the AIF master circular dated May 7, 2024, provides for ‘Giveback by the investors’ provision under Clause 31 of Para VII, which enables recovery of amounts from investors in the event of post-distribution liabilities. Thus, AIFs already have the flexibility to include such terms in their fund documents and to exercise them in the event of any liability arising after distribution. While industry feedback has indicated practical challenges in invoking giveback provisions, distribution of liquidation proceeds within the permissible fund life remains a core regulatory requirement, in the interest of investor protection.

3.5.3. Considering that the investment terms of AIFs are negotiated between investors and the investment manager, it is proposed that retention of funds beyond the permissible fund life on account of anticipated liabilities be permitted, only if investors of the fund consent to such retention. Upon receipt of the majority investor consent, the AIF/scheme of AIF shall apply and avail the status of ‘inoperative fund’.

3.5.4. It is pertinent to note that the requirement for investor consent is inevitable in these cases, since these involve retention of proceeds based on anticipated liabilities, unsupported by demonstrable claims and based on assumption. Considering the investor consent requirement, no limits may be prescribed with respect to amount or time for retention of proceeds.

3.6. Scenario 3 – Amounts retained for operational expenses

3.6.1. It is observed that AIFs also retain monies to meet residual operational expenses while winding up the AIF/scheme, such as consultant fees, retainership costs, legal fees, registrar and transfer agent charges, and costs associated with filing the PPM audit report etc. AIFs have submitted that such amounts are typically small relative to the fund size and that several expenses crystallise at the end of the financial year or towards the end of the winding-up process, making it difficult to achieve a NIL balance by the end of the permissible fund life.

3.6.2. Therefore, AIF schemes may be permitted to retain proceeds beyond the permissible fund life to meet operational expenses and obtain tagging as ‘inoperative funds’, subject to such expenses being substantiated through invoices, supporting documents, or comparability with expenses incurred in previous years. The regulatory intent is to ensure that the retained amount is deployed solely to keep the fund operative for the purpose of winding up, and the AIF should demonstrate this to SEBI.

3.6.3. As operational expenses are inherently time-bound, it is proposed that the maximum duration for which proceeds may be retained for this purpose be capped at three years from the end of the permissible fund life.

3.7. Scenario 4 – AIFs with no retained monies

3.7.1. The AIF industry highlighted certain cases where an AIF/scheme may not retain any monies beyond the permissible fund life and not have any active fund management activity, but continues to exist solely in anticipation of a potential future inflow of proceeds/capital due to possible favourable outcome of a litigation to which the AIF is a party.

3.7.2. Since such AIFs continue to bear all regulatory compliance obligations for contingent reasons under extant framework, it is proposed to extend the flexibility of being tagged as ‘inoperative funds’ to such AIFs also, to reduce their compliance requirements.

3.8. The regulatory framework applicable to funds tagged as ‘inoperative’ shall be as follows:

3.8.1. ‘Inoperative funds’ may be given the flexibility to invest such retained monies in accordance with Regulation 15(f) of the AIF Regulations, which permits temporary deployment of funds in liquid mutual funds, bank deposits, Treasury bills, Tri-party Repo Dealing and Settlement instruments, commercial papers, certificates of deposit, or other liquid assets of higher quality.

3.8.2. The regulatory compliances for such inoperative funds may be rationalised which inter-alia will allow AIFs to discontinue periodic filing with SEBI.

3.8.3. Submission of an annual status report on retained monies to SEBI and to their investors.

3.8.4. Such AIFs shall not be permitted to launch any new schemes, and no management fee shall be charged in respect of existing schemes.

3.8.5. Upon satisfaction of all liabilities and achievement of a NIL bank account balance, the AIF with inoperative funds may apply to SEBI for surrender of its registration.

3.9. This proposed regulatory approach is intended to reduce the compliance cost for maintaining these inoperative funds, while also retaining necessary regulatory oversight.

4. Consultation with Stakeholders and Public Consultation:

4.1. An agenda item in this regard was placed for discussion before the Alternative Investment Policy Advisory Committee (‘AIPAC’), in its meeting held on January 07, 2026. After deliberations, AIPAC recommended the proposals pertaining to retention of funds on account of pending litigation or tax demands, retention for operational expenses, and extension of inoperative status to AIFs with no retained monies.

4.2. As regards the requirement of investor consent for amounts retained on account of anticipated liabilities, certain AIPAC members highlighted practical challenges in obtaining unanimous consent. Based on suggestions received from AIPAC, the proposal has been modified to require consent from at least 75% of investors by value, instead of consent from all investors.

4.3. A consultation paper was issued on February 05, 2026 inviting public comments by February 26, 2026, on permitting retention of funds beyond the permissible fund life subject to specified conditions and the proposed framework for ‘inoperative funds’. A total of 102 comments have been received on the five proposals of aforesaid consultation paper from 23 commenters (including AIFs, Investment Manager, investor and AIF industry associations).

4.4. Nearly all the commenters have concurred with the proposals to allow retention of proceeds beyond permissible fund life and the introduction of ‘inoperative fund’ framework. However, various suggestions have been received on the scenarios permitted and the conditions for ‘inoperative funds’. Some of the major suggestions and our views on the same, are as under –

4.4.1. Definition of demonstrable receipt for pending litigations –

i. Commenters have submitted the definition of ‘demonstrable receipt’ should be pragmatic considering the regulatory and litigation realities. It has been suggested the said definition should include official written communication from tax authorities or regulatory bodies such as SCNs, investigation summons or preliminary notices.

ii. As mentioned earlier at paragraph 3.4.4., considering the comments received, the definition of ‘demonstrable receipt’ has been suitably modified to include any written communication from tax or other authorities.

4.4.2. Investor consent requirement –

(i) While the consultation paper had proposed investor consent requirement only for retention of reserves for anticipated liabilities, commenters have misconstrued that the same may apply for all scenarios for retention of proceeds.

(ii) It is reiterated that investor consent requirement is proposed to be mandated only for retention of reserves for anticipated liabilities, as these are not supported by demonstrable claims and are based on assumption.

4.4.3. Defining the specific heads for operational expenses for which retention is permitted –

i. Views were sought from the stakeholders on whether the specific operational heads for which proceeds may be retained should be prescribed explicitly by SEBI.

ii. Majority of the commenters have expressed that such detailed prescription of operational heads may not be desirable, considering that the template PPM for AIFs mandates disclosure of types of operating expenses and estimated caps/range for the same. Since the industry may be adopting different practices and nomenclatures for charging different types of expenses and fees, it may be difficult to make an exhaustive list of all possible operating expenses for which retention of capital may be permitted.

iii. Considering the comments received and that AIFs have to, in any case, substantiate that the reserve for operational expenses is in line with previous year’s expenses, specific heads for operational expenses may not be prescribed.

4.4.4. Tagging at scheme level, instead of AIF level –

i. Commenters have suggested that the tagging of ‘inoperative fund’ shall be carried out at scheme level, instead of tagging at AIF level.

ii. The proposal for tagging as an ‘inoperative fund’ has been designed specifically to address concerns relating to the surrender of AIF registration on account of scenarios detailed above. The intent of such tagging is to provide flexibility at the time of exit and also to prevent misuse of AIF registration where no active fund management activity is being undertaken. Therefore, it may not be appropriate to tag ‘inoperative’ status at the scheme level. However, where monies have been retained beyond the ‘permissible fund life’ at the scheme level, such details shall be reported to SEBI at the time of winding up of the concerned scheme and as an annual status report, even in cases where surrender of AIF registration is not intended/ possible.

4.4.5. Extending the flexibility to VCFs registered under erstwhile SEBI (Venture Capital Funds) Regulations, 1996 –

i. Commenters have suggested that the flexibility and framework proposed for winding up of AIFs and their schemes should also extend to VCFs registered under erstwhile SEBI (Venture Capital Funds) Regulations, 1996.

ii. As already stated above, the VCFs registered under erstwhile SEBI (Venture Capital Funds) Regulations, 1996 also face similar issues relating to winding up and surrender as mentioned for AIFs.

iii. These comments merit consideration. Accordingly, necessary policy/ procedural changes shall be facilitated by SEBI for similarly placed VCFs.

4.4.6. Untraceable investors –

(i) Commenters have highlighted scenarios where AIFs are unable to wind up their schemes due to pending distribution of proceeds to untraceable or deceased investors. Suggestions have also been received on a possible framework for dealing with untraceable investors and winding of schemes with such investors.

(ii) SEBI is in consultation with the industry on the possible solutions for addressing this issue. Accordingly, this issue and suggestions have been noted for taking a final view in this matter.

4.4.7. Reviving dormant registration –

i. Commenters have sought for extending the applicability of inoperative status to schemes that have not achieved first close and have not on-boarded any investors. In such cases although no investment activity has commenced, full compliance requirements continue to apply resulting in regulatory burden.

ii. It is pertinent to note that the ‘inoperative fund’ tag is intended to
provide some compliance relief to such funds which have carried out and completed their investment activity and are forced to continue with the registration due to unforeseen circumstances. It is intended that these funds will close down and surrender their registration upon satisfying the pending liabilities and liquidating the reserves. These inoperative funds are restricted from making any new investment and charging management fees from their schemes, considering there is no active fund management.

iii. Thus, AIFs which are in the process of attempting to raise capital before first close to achieve the minimum corpus within 12 months from the date SEBI takes PPM on record are not ‘inoperative’ per se. Extending this tagging to such funds does not align with the intent of the tagging.

4.4.8. Relaxation from other compliance requirements –

(i) Commenters have suggested that rationalised compliances should be extended to include other compliances such as cybersecurity, PPM updation, Performance Benchmarking, STPI filings, audit requirements etc.

(ii) Considering that no fund management activity is being carried out in the scenarios detailed above, the said compliance requirements may be discontinued for ‘inoperative funds’.

A copy of the consultation paper and a detailed summary of the public comments received, along with SEBI’s views on the same, are placed at Annexure A and Annexure B respectively.

5. Proposals to the Board:

5.1. Considering the recommendations of AIPAC, the public comments received on the consultation paper, and internal deliberations, it is proposed that the AIF Regulations may be suitably amended to allow AIFs or schemes of AIFs to retain liquidation proceeds beyond the permissible fund life and to enable tagging certain AIFs as ‘inoperative funds’, in the manner and subject to conditions as may be specified by SEBI from time to time.

5.2. It is further proposed that the following operational modalities and conditions for such AIFs may be specified by way of issuance of circular –

5.2.1. AIF schemes may be permitted to retain proceeds beyond the permissible fund life subject to meeting one of the following conditions:

5.2.1.1. ‘Demonstrable receipt’ of a litigation or demand from a tax authority or any other regulatory authority or law enforcement agency;

5.2.1.2. Consent from at least 75% of the investors by value of the fund, in the case of anticipated liabilities arising due to litigation or tax demand;

5.2.1.3. Substantiation of retained amounts towards operational expenses through invoices, supporting documents, or comparable expenses incurred in previous years.

5.2.2. The ‘demonstrable receipt’ may include any official written communication from a tax authority, regulatory authority, law enforcement agency or from an investor or counterparty in relation to litigation, which indicates potential tax or regulatory liability. This shall include show-cause notices, reassessment notices, or similar communications and shall not be restricted to crystallised demand notices.

5.2.3. Monies retained by AIFs/schemes of AIFs under the above conditions shall be invested in accordance with Regulation 15(f) of the AIF Regulations.

5.2.4. AIFs intending to surrender their registration and having one or more such schemes as mentioned above shall be tagged as ‘inoperative funds’. Such AIFs may apply for final surrender of registration only after settlement of all outstanding liabilities and achieving a NIL bank balance.

5.2.5. AIFs that have not retained any monies beyond the permissible fund life but continue to exist solely in anticipation of a favourable litigation outcome may also apply to SEBI for ‘inoperative fund’ status and avail the associated benefits.

5.2.6. AIFs that have retained monies beyond the permissible fund life in a scheme, that also has other schemes in which fund management activity is continuing, shall be required to submit the details of such retention to SEBI and investors at the time of winding up of the concerned scheme and as an annual status report.

5.2.7. The regulatory framework applicable to funds tagged as ‘inoperative’ shall include the following:

a. Rationalised compliances shall include discontinuation of periodic filings, PPM updation, Performance Benchmarking and any other compliance requirement as may be prescribed by SEBI from time to time;

b. Submission of an annual status report on retained monies to SEBI and to their investors;

c. Investment of retained monies strictly in accordance with Regulation 15(f) of the AIF Regulations;

d. Prohibition on the launch of any new schemes;

e. Prohibition on charging management fees in respect of existing schemes; and,

f. A maximum retention period of three years for amounts retained towards operational expenses.

5.3. The draft amendment to the AIF Regulations and the draft notification for the proposed amendment are placed at Annexure C and Annexure D respectively.

5.4. The Board is requested to consider and approve the proposals set out in this Memorandum and to authorise the Chairperson to make consequential and incidental changes and take necessary steps required to give effect to the decisions of the Board.

Endl:

1. Annexure A (01 page) – Consultation paper issued on February 5, 2026.

2. Annexure B (20 pages) – Summary of public comments received along with SEBI’s views.

3. Annexure C (01 page) – Draft amendment to SEBI (Alternative Investment Funds) Regulations, 2012.

4. Annexure D (01 pages) – Draft notification for the proposed amendment.

Annexure A

The consultation paper is available at the following link:

https://www.sebi.gov.in/reports-and-statistics/reports/feb-2026/consultation-paper-on-flexibility-to-alternative-investment-funds-aifs-in-winding-up-the-scheme-surrendering-the-registration- 99541.html

Annexure C

Amendment to SEBI (Alternative Investment Funds) Regulations, 2012, shall be notified after following the due process.

Annexure D

Amendment to SEBI (Alternative Investment Funds) Regulations, 2012, shall be notified after following the due process.