Why have portfolio management services (PMSes) become so popular in recent years? One reason is that high net-worth individuals prefer them for their wide range of customized solutions. So, it’s no wonder then that PMS providers are managing investor assets worth ₹23.7 trillion in their discretionary portfolios (discretionary assets are actively managed by PMS). Yet, PMSes are not as tax-efficient as mutual funds for equity investing.
While there is lot more flexibility in PMS. as it is not a pooled account. The portfolio of each client is managed separately, depending upon the investment strategy they opt for. But, since stocks are bought and sold by a PMS manager using the investor’s demat account, these transactions are taxable.
With mutual funds, investors are only taxed when they decide to sell their mutual fund units. On the other hand, every time the PMS manager decides to sell a stock, it would lead to capital gains tax if the transaction earns a profit for the investor.
Say, for instance, a PMS manager buys stock worth ₹5 lakh. Consider that the stock does well and gains 50% in a short span of 11 months. The PMS manager then decides to sell the stock, which is now worth ₹7.5 lakh. Since this entire transaction of buying and selling the stock is done from the investor’s demat account, the investor will have to pay short-term capital gains (STCG). With STCG taxed at 15%, there will be tax liability of ₹37,500 on gains of ₹2.5 lakh.
As the stock was held for less than a year in this case, short-term capital gain rules apply. “As mutual fund’s have pass-through status, the mutual fund is not required to pay any capital gains tax on the transactions. Only, the investor is required to pay capital gains tax at the time of withdrawing the investments,” says Nitesh Buddhadev, chartered accountant and founder of Nimit Consultancy.
In the case of mutual funds, the net asset value (NAV) is post-expenses and fees, which is included in the total expense ratio (TER) of the fund.
So, in a way, the fees are deducted from the gains when the investor decides to sell the mutual fund.
However, in the case of PMS, the management fees levied by PMS are not deducted from the value of investments when the investments are sold. As a result, the taxable gains for a PMS investor would be higher than a mutual fund investor, with all other things being equal. For example, if an investment of ₹50 lakh in an equity-oriented PMS gains 10% to ₹55 lakh, the investor would be liable to pay on gains of ₹5 lakh.
Consider the same scenario with an equity mutual fund. Here, the mutual fund’s net asset value (NAV) or the final amount that the investor will get at the time of sale would be based on the fund’s TER. So, assuming a 2% fee —translating into ₹1.1 lakh—the investor would be liable to pay tax on net gains of ₹3.9 lakh.
“As far as claims on expenses are concerned, we have had judgements that have said that investors cannot claim PMS fee as deductions. The matter is still a bit in grey area and can draw litigation,” says Ashok Shah, founding partner of NA Shah Associates.
Dividend is another area where mutual funds score over PMS. If the investor opts for growth option of mutual funds, the dividends paid by underlying companies are simply added to the net asset value of the fund. So, the investor only needs to pay tax on capital gains at the time of selling the mutual fund.
However, in the case of PMS, dividends of holding companies are credited into the account of the investor. If the dividend is more than ₹5,000, a 10% TDS (tax deducted at source) is applicable. The dividend received is added to the income of the investor and gets taxed at the investor’s income tax slab rate. The investor can claim the TDS at the time of tax filing.
PMS investors can use brokerage costs for deduction in their capital gains. The brokerage cost gets added to the cost of acquisition when buying a stock. For example, a PMS manager is charging brokerage of 0.2%. He buys a stock worth ₹1 lakh and then decides to sell it at ₹1.25 lakh. The brokerage of ₹200 (0.2% of ₹1 lakh) will get added to the acquisition cost. So, the gains for investor will be reduced to that extent ( ₹1,25,000- ₹1,00,200), which works out to ₹24,800.
In the case of mutual funds, the brokerage costs get absorbed in additional expense limit of 0.12%. If there is any spillover, it gets absorbed within the overall TER limit of the fund. Since NAV is always post-TER, investors end up getting deduction for most expenses charged by mutual funds.
