The Securities and Exchange Board of India (SEBI), vide Circular No. HO/19/34/11(2)2026-AFD-POD1/I/13764/2026 dated June 16, 2026, has specified detailed guidelines for the winding up of Alternative Investment Funds (AIFs), addressing two critical aspects: retention of proceeds beyond the permissible fund life, and the introduction of an 'Inoperative Fund' status as an interim arrangement before surrender of registration.
Background
The SEBI (Alternative Investment Funds) Regulations, 2012 ("AIF Regulations") were amended and notified on April 18, 2026, to provide AIFs greater flexibility with respect to winding up of their schemes and surrender of registration. Regulation 29 of the AIF Regulations deals with winding up, and three sub-provisions are of particular relevance here:
Regulation 29(7) requires that within the liquidation period, assets be liquidated and proceeds distributed to investors after satisfying all liabilities, subject to conditions specified by SEBI from time to time.
Regulation 29(10A) enables an AIF to be tagged as an 'Inoperative Fund', subject to conditions specified by SEBI.
Regulation 29(11) requires surrender of the certificate of registration upon winding up of the AIF.
The present circular operationalises these provisions by specifying the conditions and modalities for retention of proceeds, the process for obtaining Inoperative Fund status, and the surrender of registration.
Conditions for Retention of Proceeds Beyond Permissible Fund Life
AIFs and schemes of AIFs may now retain liquidation proceeds beyond the liquidation period or dissolution period (referred to as "permissible fund life"), provided at least one of the following three conditions is satisfied.
First, the AIF/scheme must have demonstrable receipt of a litigation notice or demand. SEBI has clarified that this is intentionally broad in scope, covering any official written communication from a tax authority, regulatory authority, law enforcement agency, court of law, or from an investor/counterparty, indicating a potential tax, regulatory, or legal liability. This explicitly includes show-cause notices, re-assessment notices, and investigation summons, and is not restricted to crystallised demand notices.
Second, where proceeds are proposed to be retained for anticipated liabilities arising from a possible or probable litigation or tax demand, the manager must obtain consent from at least 75% of investors by value of their investment in the scheme. In such cases, the manager is required to disclose to investors the amount being retained and the estimated retention period at the time of seeking consent.
Third, amounts retained to meet residual winding-up related operational expenses must be substantiated through invoices, supporting documents, or records of comparable expenses incurred in previous years. Retention on this ground is capped at three years from the end of the permissible fund life. The Standard Setting Forum of AIFs (SFA), in consultation with SEBI, will formulate implementation standards to standardise the operational heads under which such monies may be retained.
All monies retained under any of these three grounds must be invested in accordance with Regulation 15(1)(f) of the AIF Regulations. Once liabilities are satisfied and retained monies distributed to investors, the scheme stands wound up under Regulation 29.
Applying for 'Inoperative Fund' Status
An AIF with one or more schemes holding retained monies, and intending to eventually surrender its registration, may apply for Inoperative Fund status in the format specified at Annexure A of the circular, by emailing inoperativeaif@sebi.gov.in. Notably, an AIF that has not retained any monies but wishes to continue holding its registration purely in anticipation of a favourable outcome in pending litigation may also apply under this route.
Once SEBI approves the application, the AIF is tagged as an Inoperative Fund. Such a fund may apply for surrender of its certificate of registration only after liabilities are satisfied and retained monies are distributed to investors across all its schemes.
Regulatory Framework for Inoperative Funds
From the date of obtaining the Inoperative Fund tag, three conditions apply: retained monies must continue to be invested per Regulation 15(1)(f); no new scheme may be launched under the AIF; and no management fees may be charged on any scheme.
In exchange, SEBI has granted relief from several recurring compliance requirements, as detailed in Annexure B of the circular. These include the Limited Quarterly Activity Report and Annual Activity Report, audit of PPM terms, intimation of PPM changes, the Compliance Test Report, reporting to Benchmarking Agencies, NISM certification for the key investment team, the requirement of a custodian for safekeeping of securities, periodic disclosure to investors on fund investments, annual/quarterly investor reporting, and valuation requirements under Regulation 23(2) and 23(3). The effective date of non-applicability varies by requirement — some apply from the date of obtaining Inoperative Fund status, others from the subsequent financial year or quarter, as specified in the Annexure.
Annual Reporting Obligation
AIFs with retained monies under paragraph 3 of the circular, as well as those tagged as Inoperative Funds, must submit an Annual Status Report on retained monies and outstanding liabilities — to both SEBI and investors of the relevant scheme(s) — in the format prescribed at Annexure C. This report must be filed on the SEBI Intermediary Portal within 30 calendar days from the end of March of every financial year, and must continue until all liabilities are resolved and a NIL bank balance is achieved.
Applicability to Erstwhile Venture Capital Funds
The entire framework — retention of proceeds and Inoperative Fund status — extends equally to Venture Capital Funds registered under the erstwhile SEBI (Venture Capital Funds) Regulations, 1996, with the same regulatory conditions applicable as for AIFs.
Effective Date and Legal Basis
The circular takes effect immediately and has been issued under Section 11(1) of the SEBI Act, 1992, read with Regulation 29 and Regulation 36 of the AIF Regulations. The SEBI Master Circular for AIFs dated June 03, 2026 has been correspondingly updated to incorporate these provisions.
Conclusion
This circular addresses a long-standing operational challenge for fund managers , funds that have completed their investment lifecycle but remain unable to wind up due to pending or anticipated contingent liabilities. By formalising a structured retention mechanism and an Inoperative Fund status with corresponding compliance relief, SEBI has provided a workable middle path between full operational status and outright surrender of registration, while preserving accountability through annual reporting until final closure.
Compliance. Simplified. — PMK Advisors
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