Tax Implications of PMS Investing in India

In recent years, Portfolio Management Services (PMS) have emerged as a preferred investment avenue for high-net-worth individuals (HNIs) in India. These services offer personalised strategies and direct ownership of securities. Unlike mutual funds, PMS provides tailored portfolios managed by professional fund managers that align closely with an investor’s financial goals and risk appetite.

However, the taxation landscape for PMS investments is intricate and has undergone significant changes, especially with the Union Budget 2024-25 introducing new tax rates for capital gains. Understanding these tax implications is crucial for investors to make informed decisions and optimise post-tax returns. This comprehensive guide delves into the tax treatment of PMS Investing in India, the impact of recent tax reforms, and strategies to manage tax liabilities effectively.

Understanding PMS and its Tax Regime

Taxing PMS Investment

Because PMS clients own the underlying securities, the taxation of PMS investments is quite different from that of mutual funds:

• Capital Gains Taxation: Because the securities owned by PMS clients are maintained in the client’s demat account, any gain due to the disposal of the securities incurs Capital Gains Tax. The classification between short-term capital gains and long-term capital gains tax would be determined by the holding period of the securities.
• Business Income versus Capital Gains: Income from PMS Investing can be classified as either business income or capital gains, depending on the purpose of the investments at the time of purchase. This classification has important ramifications for taxation rates and the deductibility of expenses.

Recent Tax Reforms Impacting PMS Investments

The recent Union Budget 2024-25 that was presented has brought about considerable alterations to the capital gains tax structure, which would be of interest to PMS investors:

• Short-Term Capital Gains (STCG): The tax on STCG has seen an increase from 15% to 20% for assets held for less than 12 months. 
• Long-Term Capital Gains (LTCG): The tax on LTCG has seen an increase from 10% to 12.5% for assets held for more than 12 months, for an effective tax rate after cess of 13%.
• Uniform Tax Rate: A new flat rate of 12.5% tax has been set for all kinds of long-term capital gains instead of the previous differing rate structure, and with the benefit of indexation withdrawn.

The above changes will mean for portfolio management services strategies with higher levels of portfolio turnover.

Consequences for PMS Investors

High-Churn Strategies 

PMS services that involve a high level of buy and sell transactions of securities are more subject to higher tax liabilities, given the shortened period for additional investments under the increased STCG rate. For example, a short-term PMS with 100% churn over 10 years experiences a reduction in returns under the new tax regime compared to the previous one. 

Long-Term Strategies 

Considering tax is deferred to the last year, the investor would be able to take full advantage of the compounding effect and achieve higher post-tax returns than an investor in a short-term strategy. 

Expenses Deductible 

Given that income is classified as business income, investors are able to deduct expenses incurred, like PMS management fees. These expenses are not allowed as per deduction if assessed as capital gains.

Strategies to Reduce Tax Impact in PMS

• Utilise long time-frame: Long time-frames help offset higher STCG rates and use compounding effectively by aligning PMS strategies with long time-frames.
• Know ore classify income correctly: Who you consult with about whether your income is business income rather than capital gains could help maximise tax liabilities and expense deductibility.
• Track portfolio turnover: Monitoring portfolio turnover could give you an idea of the tax impact and help determine strategies.
• Stay up to date with tax laws: By updating yourself regularly on tax issues, you can keep everything current and determine tax strategies.

A Comparison of PMS versus Mutual Funds

While PMS and mutual funds demonstrate similar features of professional management with inactivity imposed by either the fund or a PMS manager, the tax treatment is different as follows:

• Mutual Funds: The investor only pays taxes on the gains realised on the fund’s net asset value (NAV), i.e., mutual funds are much more tax efficient, particularly for a high-churn, short-term strategy.
• PMS: The investor will pay taxes on each transaction made by the PMS manager, leading to increases in taxes if the PMS manager has a high-churn strategy.

Although PMS offers advantages such as bespoke portfolios created for the individual client, direct beneficial ownership of securities, and a lack of restrictions compared to mutual funds.

Wrapping Up

Navigating the tax implications of PMS Investing in India requires a nuanced understanding of the evolving fiscal landscape. The recent tax reforms underscore the importance of strategic planning and professional guidance to optimise post-tax returns.

For investors seeking personalized portfolio management with a keen focus on tax efficiency, partnering with experienced professionals is crucial. Gravitas Investments offers comprehensive PMS solutions tailored to individual financial goals, ensuring that your investments are managed with expertise and aligned with the latest regulatory frameworks.