Why investing in MF is better than AIF and PMS

Equity MFs are more often recommended by experts as long term products. And once the investor invests in the MF, there is no tax compliance and taxes paid unless he exits or redeems.

In case of PMS or AIF investment, even if the investor remains invested for a long period, the fact that the PMS manager keeps exiting and makes new investments, makes the investor liable to pay tax while earning nothing and Also reports profit. /Loss on annual basis. In case of AIF, Category I and II Aadhaar pass-through, the investor is expected to pay tax whenever the income is earned, even if there is no distribution by the AIF. Further, in both PMS and AIF I and II cases, the investor is bound to pay advance tax during the year. In Category III AIF, the investor gets to know his share of the income disclosed as exemption in return of income, but still worse than in MF where tax payment is deferred till redemption/realization of cash flow.

Worse yet, is the case of a newly launched AIF, in which the fund has not yet invested and has in the meantime put money in short-term products that generate some income. Such income is not available to the investor and cannot really be counted as ‘income’ if one has to account for fund management charges. So even if the NAV does not increase, the investor can pay tax directly in case of Category I and II, and through the fund in case of Category III. The issue of deduction of fund management expenses applies equally to PMS. Here, the annual capital gains and other income reports do not take into account the expenses of the PMS manager.

Thus, the investor has to decide whether such expenses should be deducted while reporting the income in the income tax return. For MF investors, NAV is the net of all expenses including fund management expenses, and hence is effectively deducted from profit on exit. In MF, the investor pays tax on redemption of investment. In addition, a further complication arises in the case of damages from Category I and II AIFs. Losses can be considered for set=off by investors against other gains. However, this benefit is limited to those unitholders who have been holding units of AIF for at least 12 months. However, this issue does not arise for MF or PMS investors as no similar restrictions or conditions exist with respect to holding by the original investor.

All this certainly makes a huge difference in terms of tax compliance at the end of each year. No doubt even from a tax point of view, mutual funds are right!

Sunil Gidwani is partner of Nangia Andersen LLP.