Are tax filing complexities forcing HNIs to ditch PMS and opt for AIF?

An increasing number of high networth individuals or HNIs are migrating from portfolio management schemes (PMS) to Alternative Investment Funds (AIF) due to lower tax complexities even as AIFs mandate a larger investment ticket size.

Filing income tax returns in a PMS scheme can be a cumbersome process as all transactions occur in the investor's own demat account, which means that every trade executed by the fund manager triggers a tax event for the individual.

On the other hand, AIFs offer post-tax returns to the investor and hence there are not much complexities at the investor level in terms of filing of tax returns.

The year-on-year (YoY) growth in total commitments raised by AIFs as of June 2024 stood at 1.39x, slightly higher than the growth in the discretionary PMS assets under management at 1.2x.

“If an HNI has say investments in five to seven different PMS strategies, and on an average each of them have say 30-40 percent churn which is quite normal these days, the overall number of transactions for the client in a year becomes very high and adds to the additional work at time of filing income tax returns,” said Aniruddha Sarkar, chief investment officer at Quest Investment Advisors.

He further said that a scenario wherein a particular scheme is long on a stock while another is short on the same stock could also create a lot of difficulties while compiling all the transactions at the time of tax filing.

Market participants add that while complexities with tax on churn is not always the only case for a client to shift to an AIF, it can act as a catalyst especially when a particular scheme is not doing well.

"If PMS is underperforming, than an investor would equally consider an AIF option while realigning his PMS in look out for better performance and taxation convenience will then be a factor that investor will consider in favor of AIF," said Kamal Manocha, Founder, PMS AIF WORLD.

While both AIFs and PMS schemes have to pay tax when they churn their portfolio, the latter comes with an extra baggage of work for the clients as tax computations need to be done at the client level.

Yogesh Kalwani, Executive Managing Partner - Product and Investment Advisory at Incred Asset Management said that PMS and AIFs have similar tax implications, where taxes are incurred when stocks are bought or sold, but in AIFs, the fund handles tax payments on behalf of investors, and is paid by the fund making it more convenient for investors.

“In a PMS scheme, the client has to file taxes based on the audited financial statements available from every manager which is an additional operational responsibility which falls on an investor (which is not the case when) compared to an AIF,” he said.

A section of market participants, however, believe that while clients have to take on some extra responsibility when filing taxes under a PMS scheme, the process isn't as daunting as it seems.

“Previously, determining the cost of acquisition and holding period for securities of the same company purchased through multiple demat accounts was complex, as PMS providers operate independently, using separate demat accounts for each client,” said Rahul Chakra, partner at Economic Laws Practice. He said that these discrepancies often surfaced only during year-end time during capital gains computation.

“However, after the issuance of CBDT Circular No. 768 in 1998, the process became streamlined, as the use of distinct demat accounts by PMS providers simplified tracking acquisition costs and holding periods, making the computation hassle-free,” he said.While the minimum investment size in an PMS scheme is Rs 50 lakh, the same is pegged at Rs 1 crore for AIFs.