Home / Money / Personal Finance /  Why investments in MFs are better than AIF and PMS
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Alternative Investment Fund (AIF) and portfolio management service (PMS) are two popular vehicles for investing in the stock markets. Yet, mutual funds (MFs) are perhaps the best product and least controversial from a tax compliance perspective as well as for ease of monitoring income flows such as dividends and interest receipts. Over the last two decades, the number of issues, ambiguities, and controversies faced by MFs as a structure and by investors are negligible, as compared to PMS and AIF products.

Equity MFs are more often recommended by experts as long-term products. and once the investor invests in a MF, till he exits or redeems, there is no tax compliance and payment of taxes.

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In the case of a PMS or AIF investment, even if the investor remains invested for the long-term, the fact that the PMS manager keeps exiting and making fresh investments, makes the investor responsible for payment of tax while earning nothing and also report gains/losses on an annual basis. In the case of AIFs, category I and II basis pass-through, the investor is expected to pay tax as and when the income is earned even in the absence of any distribution by the AIF. Further, in both PMS and AIF I and II cases, the investor is obliged to pay advance tax during the year. In category III AIF, the investor gets to know his share of income disclosed as exempt in the return of income, but still fares worse than MFs where tax payment gets deferred till redemption/receipt of cash flows.

Worse still is a case of a newly launched AIF wherein the fund is yet to make investments and in the meantime parks money in short-term products earning some income. Such income is not available to the investor and may not really count as ‘income’ if one were to account for fund management fees. So even if the NAV may not show appreciation, the investor may end up paying tax either directly in the case of categories I and II, and through the fund in the case of category III. The issue of deductibility of fund management expenses is equally applicable to PMS. Here, annual capital gain and other income reports do not take into account the PMS manager’s expenses.

Thus, the investor has to take a call on whether such expenses should be deducted while reporting the income in his income tax return. For MF investors, the NAV is net of all expenses including fund management expenses, and hence effectively deducted from gains on exit. In MFs, the investor pays tax on redeeming the investment. Further, another complication arises in case of loss from category I and II AIFs. The loss can be considered by investors for set=off against other gains. However, this benefit is restricted to unitholders who hold the units of the AIF for at least 12 months. However, this issue does not arise for MF or PMS investors because no similar restrictions or conditions relating to holding by the original investor exist.

All this certainly makes an enormous difference in terms of tax compliance at the end of each year. No doubt from a tax perspective as well, mutual fund sahi hai !

Sunil Gidwani is partner at Nangia Andersen LLP.

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