What is the Tax Treatment for PMS?

Portfolio management service (PMS) has emerged in a big way since they were first permitted in India in 1993 under SEBI PMS rules. An important aspect of PMS is PMS taxation. Now taxation of PMS matters because investors are eventually interested in knowing how much they earn in post-tax terms. Here we look at how is PMS taxed and the nuances of PMS taxation in India. The taxation of PMS is very different from the taxation of mutual funds since the PMS is just seen as the purchase and sale of assets by the PMS on your behalf. That is why the Taxation of PMS needs to be understood in greater detail.

Tax Treatment for PMS

Before we understand the PMS taxation, let us first understand how PMS is different from a traditional mutual fund. Here are some key differences.

• In PMS, the investors directly own the stocks while the stocks are owned indirectly in the case of mutual funds via units.

• Mutual funds do a one-size-fits-all approach to investing based on scheme objectives. In the case of PMS, it varies based on the risk appetite and individual objectives.

• PMS is less prone to exposure restrictions. For example, mutual funds have a cap of 10% of AUM in a single stock. There is no such capping condition for PMS.

• The fees in the case of a mutual fund are fixed and built into the expense ratio. However, in the case of PMS, it can vary on a case-to-case basis based on performance.

• The ticket size in mutual funds is as low as Rs.5,000 for lump-sum investments and Rs.1,000 for SIPs. In the case of PMS, the bare minimum is Rs.50 lakhs.

Let us turn to the important subject of PMS taxation

The first thing to understand is that the mutual funds have the benefit of Section 10 (23D) of the Income Tax Act as a pass-through entity so MFs are not subjected to taxation. However, in the case of PMS taxation, there is no such facility so all transactions done by the PMS (even discretionary) are happening directly from the Demat account of the client. Hence it will be treated as normal capital gains earned by a client on his / her equity activity. The PMS taxation will be based on that premise.

Another important question is whether PMS taxation should be done as capital gains or business income. Here, PMS is not treated as an intermediary like a mutual fund. Hence the PMS transactions are treated as buy and sell transactions in the Demat account of the client, which is only authorized to be executed by the PMS based on best judgment. Since the treatment of income on PMS is the same as normal capital market transactions, the logic for classification between business income/capital gains is also based on the same principles.

Since there is no specific provision that defines PMS taxation, the PMS taxation will be done using the same principles of taxing profit from share transactions like volume, frequency, intention, holding period, etc. This will govern the definition of PMS taxation in this case. However, the plethora of legal cases, judgments, and precedents show that the issue is far from settled and is still open to debate. The idea is that you adopt one justifiable method of showing PMS income (either capital gains or business income) and be consistent about it.

An interesting aspect of PMS taxation is concerning the admissibility of deduction towards service charges and other fees paid to the PMS. Here there is a dichotomy in PMS taxation. If the investor shows PMS income as capital gains, such expenses are not admissible. However, if the client shows PMS income as business income, such expenses become automatically admissible.

Even though Courts and the CBDT have laid down the principles to differentiate between business income and capital gains, there is room for litigation. In the absence of clarity from the CBDT, the best approach would be to seek legal opinion and maintain consistency in the method adopted.

Who Should Invest in PMS

PMS is an exclusive service for investors with a corpus of Rs.50 lakhs and more. It is for investors who are willing to pay a higher fee and are open to profit-sharing subject to performance parameters. This is meant for clients who are keen on a much higher level of customized and personalized portfolio services.

Advantages of Investing in PMS

Here are some of the key advantages of a PMS service.

1. PMS gives the advantage of professional management of portfolios to deliver consistent long-term performance with controlled risk and expert monitoring.

2. The operation of PMS is largely hassle-free. The PMS virtually takes care of all the administrative aspects of the client’s portfolio with periodic reporting to the client.

3. The flexibility in PMS works to the advantage of both. The customer has less micromanagement to do. The PMS fund manager has greater leeway in performing.

4. PMS is transparent in that it provides comprehensive communications and performance reporting. Web-enabled access is another edge. Accounts statements are self-explicit.

5. Above all, there is customized advice rather than the kind of mass portfolio decisions in a mutual fund. These create a more tailor-made portfolio for the client in sync with their unique risk appetite and return expectations.