Portfolio Management Services (PMS): Concept & Taxation

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Portfolio Management Services (PMS): Concept & Taxation

 

 

Stock market is at an all-time high now and attracting a lot of new investors as well. Considering the volatility, sensitivity and speculation involved in the share market, several investors move from direct equity investment to either mutual funds investment or portfolio management schemes (PMS).

PMS is attracting a lot of High Net-Worth Individual (HNI) & has emerged as one of the most popular options in the recent past. PMS is an investment management service wherein a team of experienced portfolio managers with their track records, past experience & strong research base manages the investment of their clients. With their deep understanding of the market, they assure better returns to the investors. PMS could be discretionary or non discretionary, depending upon whether the portfolio manager has the autonomy to make all the decisions on behalf of the investor without any interference of the investor. It could be in the nature of Advisory as well wherein the portfolio manager has the primary role of just giving the advice to the clients regarding the investment decisions.

How does it work?

Portfolio managers normally require separate demat account, trading account & bank account in the name of investors and all the buying/selling activities are carried out by the service provider in the name of the investor only. Investors are very well aware of the shares bought & sold.  Normally, an agreement is signed wherein the investor authorises portfolio manager by giving a power of attorney for operating his trading and bank account. The portfolio management services are regulated by SEBI which has prescribed regulations for safety of the investors. The portfolio manager levies charges such as entry load, management charges and profit sharing fees which keep on varying from person to person depending upon the amount, volume and performance. It may be noted that there is no performance Guarantee is given under the PMS.

Difference between mutual fund and PMS

Though ultimate investment in both the case is in the stock exchange, there are several considerable differences as under:

  1. Investors directly own the stocks in case of PMS whereas it is owned indirectly in case of Mutual fund.
  2. In Mutual funds, common investment is done for all the investors in any one scheme as per its scheme objectives whereas investment in PMS keeps on varying from investor to investor depending upon his risk appetite & individual objectives.
  3. In mutual funds there is a cap of 10% of AUM in a single stock. There is no such capping in PMS.
  4. The fees / charges in case of mutual fund is fixed whereas it keeps on varying in case of PMS on a case to case basis.
  5. Mutual fund investment can start with a meagre SIP amount of just Rs. 1,000/- whereas PMS need a higher ticket size of say Rs. 50 Lakh.

Taxation of PMS:

  1. An important question arises about the taxation of investment, whether profits earned through PMS is taxable as business income or a capital gain income? This issue has assumed greater importance as the tax rate varies significantly under the two heads. If business income, it will be taxed at the slab rate applicable to the traders whereas if taxed as capital gain then Short Term Capital Gain (STCG) will be taxable @ 15% whereas Long Term Capital Gain (LTCG) will be exempt up to Rs. 1 Lakh and balance amount would attract tax rate of just 10%.
  2. At present, there is no specific provision which provides for taxation of PMS income & so it is taxed under the normal provision. The normal principle of taxing profit from share transactions like volume, frequency, intention, holding period, etc of the investment would continue to govern the taxation of PMS. Taxation in such cases is a matter of debate, divergent & conflicting views. In general, the principles governing the taxation in case of direct investments will govern the taxation of PMS as well.
  3. Courts have held that transactions carried out by the PMS Manager are in the nature of transactions for maximisation of wealth rather than withdrawing the profits on appreciation in value of shares. Since the taxpayer was engaged in systematic activities of holding portfolio through the PMS Manager, it could not be said that the main object of holding the portfolio was to make profit by sale of shares during the course of its investment activities. With this view, profit from PMS can be characterised as “Capital Gain” income. One can place reliance on the following cases:
  4. Salil Shah Family P. Trust vs. ACIT [2013] 36 taxmann.com 543 (Mumbai ITAT.)
  5. KRA Holding & Trading Pvt. Ltd. vs DCIT 2011 (5) TMI 498 (Pune ITAT)

iii.CIT vs. Kapur Investment Pvt. Ltd. [TS -318- HC-2015 (Kar.)

  1. Radials International vs. ACIT [2014] 367 ITR 1 (Del.)
  2. Apoorva Patni vs. ACIT [2012] 24 taxmann.com 223 (Pune)
  3. In Radials International vs. ACIT, Delhi High Court has reversed the order of Delhi Tribunal and held the gains from PMS transactions are capital gains and not business income.

vii. ARA Trading & Investments P. Ltd by Pune ITAT

  1. Another interesting issue in the taxation of PMS is with regard to admissibility of deduction towards service charges/fees paid to portfolio managers. If the taxpayer is offering the income from PMS as business income then the admissibility of deduction is not questionable and it will be eligible for deduction u/s 37.
    However, if the assessee is treating it as capital gain income, then the issue is highly debatable with judgement on either side.
    While computing capital gain income, only deductions permissible are (a) Expenditure incurred wholly or exclusively in connection with the transfer (b) cost of acquisition (c) cost of improvement. In short, deduction shall be admissible only if PMS fees, charges etc can be classified under any of above.

Few courts have ruled that it is eligible for deduction as the expression “in connection with such transfer” has a wide meaning and all expenditure having a nexus with the transfer is allowable. One can rely on KRA Holding & Trading Pvt. Ltd. vs. DCIT (2011) 46 SOT 19 Pune ITAT,  Serum Institute of India Ltd. – ITA No. 1576/ PN/2012 and 1617/PN/2012) ITAT Pune dated 18-2-2015, M/s Amrit Diamond Trade Centre Pvt. Ltd., ITA No. 2642/ Mumbai ITAT (date of Order 15-1-2016), Shri Nadir A Modi, Mumbai ITAT – ITA No. 2996/Mum/2010 & 4859/Mum/2012 Order dated 31-3-2017 & Joy Beauty Care P. Ltd. Kolkata ITAT – ITA No. 856/Kol/2007 – Order dated 5-9-2018.

However, in Manteen Pyarali Dholkia vs. DCIT (2018) 171 ITD 294 & Homi K. Bhabha, Mumbai vs Assessee [ITA No.3287/Mum/2009], deduction towards PMS fees was denied. Deductions claim would be full of disputes and litigation unless and until it is specifically clarified by the Board or settled by the judiciary.

Even though the Courts & CBDT have laid down the principles to differentiate between business income & capital gain income, still there is a room for litigation, divergent views & multiple controversies. In order to reduce this litigation, it would be better if CBDT clarifies the issues or a special provision is incorporated so as to provide for taxation of income from PMS investment.

 

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