PMS & AIF Tax Planning

Under a Portfolio Management Service, the securities are held in the client's own demat account, so all capital gains accrue directly to the client and must be reported in the client's ITR under Schedule CG. The fund manager is not responsible for your tax filings. Short-term capital gains on listed equities held less than 12 months are taxed at 20% under Section 111A of the Income Tax Act 1961 (as amended by Finance Act 2024, effective July 23, 2024), and long-term gains exceeding ₹1.25 lakh per year are taxed at 12.5% under Section 112A. PMS transaction statements often bundle scrip-level trades that must be individually reconciled — a common source of under-reporting that triggers scrutiny under Section 143(2).

Category II AIFs are pass-through vehicles under Section 115UB of the Income Tax Act 1961: income (other than business income) retains its character and is taxed in the investor's hands as if the investor had earned it directly. The AIF must file a Statement of Income Distribution in Form 64B with the Income Tax Department. Losses from a Category II AIF can be passed through and set off by the investor against income of the same nature, subject to the normal set-off rules under Chapter VI. The AIF deducts tax at source on distributed income under Section 194LBB at 10% for resident investors and at applicable treaty or 40% rates for foreign investors.

Interest income from a Category I AIF classified as an Infrastructure Debt Fund is taxable in the investor's hands under Section 115UB read with Section 10(47) of the Income Tax Act 1961 — Section 10(47) exempts the fund entity itself but does not exempt distributions to investors. The AIF deducts TDS on interest distributions at 5% for non-resident investors under Section 194LBA and at 10% for resident investors under Section 194LBB. Investors must include the gross distribution (before TDS) in their income and claim the TDS credit in their ITR. Proper co-ordination between the AIF's Form 64C (investor-level allocation certificate) and the investor's Schedule TDS is essential to avoid double taxation or mismatch notices.

Management fees paid to a PMS manager are not deductible as a cost of acquisition or cost of improvement under Section 48 of the Income Tax Act 1961 for capital gains computation purposes. The Supreme Court in CIT v. Escorts Finance Ltd has affirmed that only expenditure directly connected to the transfer is deductible under Section 48(i). Some assessees have claimed PMS fees as a business expense under Section 37(1) where the investment activity constitutes a business, but this requires that the portfolio is held as stock-in-trade, not as capital assets — a fact-specific determination that must be supported by documentation and consistent return filings. Any misclassification risks disallowance and penalties under Section 270A.

For resident individuals with total income exceeding ₹5 crore, the surcharge rate is 37% under Section 87 of the Income Tax Act 1961 (pre-Finance Act 2023 rates still apply for AY 2026-27). However, for long-term capital gains on units of equity-oriented funds or listed securities taxable under Section 112A, the surcharge is capped at 15% by virtue of Section 112A read with the Finance Act 2022 amendment. For other LTCG from AIF units (e.g., unlisted securities via a Category III AIF) taxable under Section 112, no such surcharge cap applies, and the effective rate can reach 28.496% (20% tax + 37% surcharge + 4% cess). Proper categorisation of the underlying asset class at the AIF level — confirmed via Form 64B — is therefore critical to computing your correct effective rate.