Secondaries & Continuation Funds

2.1 LP led secondary transactions

In an LP-led secondary transaction, an LP opts to sell its investment in one or more private equity funds prior to their scheduled maturity to other investors. These are bilateral deals, requiring prior GP consent and the buyers will assume all rights and obligations of the selling LP, including any outstanding capital commitments.

ILLUSTRATION:

4. Precedent for GP-led secondaries in India – ChrysCapital Continuation Fund

Lessons from the ChrysCapital Deal for Indian PE:

1. Proved the template: India’s secondary market can support large, institutionally led CV transactions at scale.
2. Normalized CVs: Has made other Indian GPs comfortable with the CV structure, multiple CVs are now in the pipeline.
3. Asset quality premium: High-quality, near-IPO assets attract near-par (or zero discount) pricing in India secondaries, unlike stressed asset sales.
4. LP sophistication: Demonstrates that Indian LPs are willing and able to evaluate roll-over vs. cash-out decisions, a sign of market maturity.

Secondary transactions in India almost exclusively involve Category II AIFs (private equity / venture capital funds) and, to a lesser extent, Category I AIFs (infrastructure / social venture funds). Following are key regulatory provisions governing the secondary transactions:

1. Registration Requirement: Given the absence of a specific AIF regulatory framework for CVs in India, any GP‑led secondary implemented through a CV would require the vehicle to be constituted as a new fund and obtain a fresh AIF registration or establish a new scheme.
2. Diversification Norms: Regulation 15(1)(c) prohibits Category I and Category II AIFs from investing more than 25% of investable funds in a single investee company, whether directly or through units of another AIF. Large Value Funds are provided a relaxation, allowing them to invest up to 50% of their investable funds in a single investee company (doubling the standard limit). 
3. Transfer of assets: A CV (registered either as a new fund or as a new scheme of the same fund) is typically managed or sponsored by the same Manager or Sponsor as the Selling Fund, or by an affiliate within the same group. In such cases, the transfer of assets from the Selling Fund to the CV, being an associate of the Selling Fund, would require the approval of at least 75% of investors by value of their investment. Regulation 15(1)(ea) of the AIF Regulations therefore remains a key regulatory hurdle for asset transfers between funds or schemes under common management. To further strengthen governance, any investor holding 50% or more of Selling Fund’s corpus who is also a buyer in the CV must be excluded from the voting process. This exclusion operates as a critical safeguard against conflicts of interest in GP‑led secondary transactions.
4. Continuation Vehicle as New Scheme: Where a CV is structured as a new scheme under an existing AIF’s umbrella, instead of a new fund, such a scheme must have its own minimum corpus, its own PPM, and maintain segregated bank accounts and assets.
5. Conflict of Interest: SEBI places onerous obligations on GPs to manage conflicts where the same GP is on both sides of a GP-led secondary i.e., for the Selling Fund and the new CV. An independent LP Advisory Committee (LPAC) review and, ideally, an independent process adviser (investment bank), are market standards for GP-led deals.
6. Valuation: SEBI mandates that AIF investments be valued at fair value using standardized methodologies (per SEBI’s valuation framework and the AIF industry association guidelines). The NAV at which a CV acquires assets from the Selling Fund must be defensible and independently verified.

Secondary transactions involving a foreign investor (either as buyer or seller) are governed by the Foreign Exchange Management Act, 1999 (“FEMA”) and the Foreign Exchange Management (Non-Debt Instruments) Rules, 2019 (“NDI Rules”). Mandatory fair-value pricing rules under the NDI Rules are paramount. The key principle here is: a resident Indian selling shares/units to a non-resident cannot do so below the FEMA-determined fair value, and a non-resident selling to a resident cannot do so above that fair value. This is the ‘floor-ceiling’ mechanism.

1. Implication for CV pricing: When a foreign-owned CV acquires assets from a domestic fund, or when foreign secondary buyers invest in a CV, the transaction price must be at or above (for sales by residents) the FEMA-prescribed fair value. If a secondary deal is struck at a 20% discount to book NAV, the parties must ensure this discount does not violate FEMA pricing i.e., the ‘NAV’ used must be the intrinsic FEMA-recognized fair value, not a stale book value.
2. Foreign-Owned and Controlled AIF: As per the NDI Rules, an AIF where the Sponsor or the Manager or the Investment Manager (i) is not owned and not controlled by resident Indian citizens or (ii) is owned or controlled by persons resident outside India, such AIF is classified as a ‘foreign-owned and controlled’ AIF. This classification is critical, it triggers FDI-route pricing and sectoral cap compliance for every portfolio investment by such AIF.
3. FEMA Reporting: Every cross-border investment into or out of an AIF must be reported to the RBI via the FIRMS portal within prescribed timelines (typically 30 days of allotment / transfer).
4. Press Note 3 / Land Border Rule (“PN3”): When an AIF with beneficial investors from land border sharing countries (covering China, Pakistan, Bangladesh, Nepal, Bhutan, Myanmar, and Afghanistan) (“LBC”) makes a downstream investment into an Indian portfolio company, that investment attracts PN3 scrutiny. The portfolio company receiving such investment is required to seek prior government approval, where required, if the AIF’s beneficial owner is traced back to an LBC entity. 

For international GPs and secondary investors, GIFT City (International Financial Services Centres -regulated (“GIFT IFSC”)) may offer meaningful advantages over onshore AIF structuring:

1. Tax-neutral relocation: Transfers of interest from an existing foreign fund to a GIFT IFSC fund are not treated as taxable transfers for capital gains purposes. Correspondingly, any transfer by a shareholder, unit holder, or interest holder of a capital asset being a share, unit, or interest held in an existing foreign fund, in consideration for a share, unit, or interest in the GIFT IFSC resultant fund, is also not treated as a taxable transfer for capital gains purposes. The sunset for the above benefits have been extended to 31 March 2030.
2. Greater structural flexibility under IFSCA Fund Management Regulations 2025 (“IFSCA FM Regulations”) vs. AIF Regulations.
3. Example of a CV domiciled in GIFT IFSC: Kedaara II Continuation Fund

Unlike Category I and II AIFs, Category III AIFs do not benefit from a statutory pass-through regime. All income earned by a Category III AIF, whether in the nature of capital gains, interest, dividends, or business income is taxed at the vehicle level, with the fund itself bearing the full tax liability before any distribution is made to investors. The applicable rate depends on the legal form of the fund: 

1. where the AIF is constituted as an indeterminate trust, the trustee is assessed as a representative assessee and income is ordinarily chargeable at the maximum marginal rate (~42.74% under the prevailing surcharge regime for indeterminate trusts);
2. where the AIF is constituted as a determinate trust, the trustee is assessed as a representative assessee and each class of income is taxed at the rate applicable to each beneficiary’s proportionate share, as if the income had accrued directly to them; provided that where such income includes profits and gains of business, the entire income is nevertheless charged at the maximum marginal rate;
3. where it is incorporated as a company or LLP, the applicable corporate or LLP tax rate applies instead.

Framework: Pass-Through vs. Entity-Level Taxation

The tax treatment of secondary transactions in India depends fundamentally on the AIF category and the nature of income:

5.4.2 Capital Gains Taxation 

1. Capital Asset Classification (Budget 2025 / New ITA 2025): From AY 2026-27, securities held by Category I and II AIFs are statutorily defined as ‘capital assets’. This means gains from their sale will always be taxed as capital gains and not business income, eliminating a significant source of uncertainty that had created litigation risk for secondary transactions. 
2. Long-Term Capital Gains (LTCG): For listed equity and equity-oriented assets, LTCG (held > 12 months) is taxed at 12.5% (post-Budget 2024) with a Rs. 1.25 lakh annual exemption. For unlisted securities, and units of Domestic AIFs (the more common case in PE secondaries), LTCG (held > 24 months) is also taxed at 12.5% without indexation.
3. Short-Term Capital Gains (STCG): Listed equity STCG (held < 12 months) is taxed at 20%. Unlisted STCG, and units of Domestic AIFs are taxed at the investor’s applicable slab rate.
4. Capital gains tax implications on transfer of units of foreign funds would depend on applicability of indirect transfer provisions and DTAA relief, if any, depending on the LP’s country of residence.
5. Unlisted Debt Reclassification (Section 76 of the ITA 2025 [erstwhile Section 50AA of the ITA 1961], from July 23, 2024): All gains from sale of unlisted bonds and debentures are now treated as STCG, regardless of holding period. This is a significant change for credit funds and hybrid fund secondaries. SWFs and pension funds are exempted from this provision.

5.4.3 TDS Obligations (Section 393 of the ITA 2025 [erstwhile Section 194LBB of the ITA 1961])

A buyer acquiring an LP interest in a secondary deal must conduct tax due diligence covering:

1. Vintage of underlying portfolio companies and likely gain characterization (STCG vs. LTCG);
2. Unresolved tax demands or notices at the fund level;
3. Whether any portfolio company has been subject to GAAR (General Anti-Avoidance Rule) proceedings;
4. Deferred tax liabilities embedded in the portfolio, especially for unlisted holdings carried at cost that have appreciated significantly;
5. TDS credit position of the selling LP as unpaid TDS could create liability for the buyer in certain structures;
6. Transfer pricing compliance for any cross-border transactions within the portfolio.

Stamp duty on the transfer of LP interests varies by state and structure:

1. Transfer of unlisted demat shares in an Indian company: 0.015% on the consideration amount
2. Transfer of unlisted demat AIF units: 0.015% on the consideration amount
3. Assignment of LP interest in a Trust-form AIF: The trust deed / deed of assignment may attract stamp duty at rates varying by state (in Maharashtra anywhere between: 0.1–3%; this is a live issue that requires state-level analysis).

In a GP-led secondary, the GP structurally sits on both sides of the transaction, as the fiduciary of the Selling Fund and simultaneously as the promoter of the acquiring CV, creating conflict.

1. AIF Regulations mandate conflict management but prescribes no standardised safe harbour protocol specific to GP-led secondaries; the market currently relies on LPAC reviews and independent advisers as a best-effort mitigation, not a mandated framework.
2. There is no regulatory requirement in India (unlike the SEC’s proposed rules in the U.S.) for GPs to engage a fully independent fairness opinion provider or to formally establish a “qualified independent reviewer” for CV transactions.
3. The risk of GP self-dealing is heightened in single-asset CVs, where the GP’s carry economics in the new vehicle can be substantially restructured, potentially at the expense of legacy LPs who lack the information or leverage to negotiate.

Valuation in a GP-led secondary is inherently asymmetric: the GP controls the information on the asset and has an economic interest in the pricing outcome, while LPs must make roll-over or cash-out decisions based on a NAV that the same GP has substantially influenced.

1. SEBI’s valuation framework mandates fair value using standardised methodologies, but there is no mandatory requirement for an independent third-party valuation specifically commissioned for the CV transfer, the fund’s existing registered valuer report often serves a dual purpose.
2. In cross-border structures, the FEMA “floor-ceiling” pricing mechanism (under the NDI Rules) adds a second, sometimes conflicting layer of pricing discipline, the FEMA-recognized fair value may diverge from the secondary market’s negotiated transfer price, particularly where the asset is illiquid or unlisted.
3. India lacks a secondary market pricing database or benchmarking infrastructure (comparable to Preqin or Greenhill’s secondary pricing surveys globally), making it difficult for LPs to independently assess whether the offered NAV reflects genuine market discovery.

Regulation 15(1)(ea) of the AIF Regulations establishes a 75%-by-value investor approval threshold for asset transfers to affiliates, which is a meaningful governance check, but its practical enforcement is constrained by the passive and fragmented nature of most Indian LP constituencies.

1. The exclusion of any LP holding 50% or more of corpus who is also a buyer in the CV (designed to prevent conflicted voting) is a sound safeguard in principle, but it can create practical quorum and threshold-computation difficulties in funds with concentrated anchor investors.
2. Many Indian fund LP Agreements may not comprehensively specify the procedural mechanics for GP-led secondary consent, including notice periods, information rights for roll-over decision-making, or deemed consent provisions, leaving LPs without adequate contractual protection at the time of the transaction.
3. Smaller domestic LPs (family offices, HNIs) typically lack the legal and financial sophistication to independently evaluate roll-over vs. cash-out economics, creating an informational asymmetry that the market has not yet addressed through standardised disclosure norms.

The AIF Regulations, having been designed for primary fund structures, impose several provisions that sit awkwardly with the mechanics of GP-led secondaries and CVs.

1. The 25% single‑investee diversification cap under Regulation 15(1)(c) significantly constrains the use of single‑asset CVs for AIFs established in mainland India. Given that single‑asset CVs are widely used globally for their commercial efficiency, where a CV is intended to house a single asset, incorporating such CV in GIFT IFSC or an offshore jurisdiction (subject to applicable legal and regulatory requirements) may be considered to mitigate this restriction.
2. The absence of a dedicated CV registration track under SEBI’s AIF framework means every CV must be freshly registered as a new AIF, incurring duplicative compliance costs, minimum corpus requirements, and PPM preparation timelines, creating structural inefficiency that global markets operating under purpose-built GP-led secondary frameworks do not face.
3. GIFT IFSC domiciled CVs, while offering meaningful tax and structural advantages, attract full FEMA compliance on asset transfers to/from mainland India funds, and the regulatory treatment of such cross-border intra-group transfers remains an area of live interpretive uncertainty.

India’s secondary market, while growing rapidly, remains a thin and largely relationship-driven market, characterised by limited competitive tension in pricing and an absence of the institutional infrastructure that underpins mature secondary ecosystems in North America and Europe.

1. The buyer universe is concentrated, a handful of dedicated secondary funds and global secondaries arms of funds-of-funds dominate deal flow, meaning GPs have limited ability to run competitive secondary processes that would yield genuine price discovery.
2. There may not be standardised secondary transaction documents, LP transfer templates, or market-accepted representation and warranty frameworks specific to Indian AIF secondary sales, leading to prolonged and bespoke negotiations that increase transaction costs and execution risk.
3. The LP base for Indian AIFs remains heavily domestic and institutional-light; the absence of large, sophisticated domestic LPs (comparable to U.S. pension funds or endowments) with active secondary portfolio management mandates limits the supply side of LP-led secondary transactions and suppresses market depth.

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