Last Updated: May 25, 2023
PMS Taxation
PMS is a pass-through vehicle from a tax perspective.
Pass-through PMS Taxation: Since under a PMS, investments are held directly in the investor’s name (and not via a trust like in a MF or AIF), the tax liability for the PMS investor is the same as the investor directly buying or selling shares/securities in his own name.
Accordingly, the taxation of PMS investments are as follows:
- Equity Capital Gains: 15% (ST – less than 1 year holding) / 10% (LT – greater than 1 year holding … 1 lakh exemption)
- Non-equity Capital Gains: added to income (ST – less than 3 year holding) / 20% with indexation (LT – greater than 3 year holding)
- Equity Dividend Income: added to income
- Interest Income: added to income
AIF Taxation
Taxation of AIF’s are based on 2 factors:
- AIF Classification
- Fund Legal Structure
AIF Classification
Alternate Investment Funds (AIFs) are categorized as follows:
- Category I (CAT 1): Funds that invest in start-up or early-stage ventures. This extends to social ventures or SMEs or infrastructure or other sectors or areas which the government or regulators consider as socially or economically desirable.
- Category II (CAT 2): Funds that do not fall under CAT 1 and CAT 3, do not undertake leverage or borrowing.
- Category III (CAT 3): Funds that employ diverse trading strategies. They use leverage through listed and unlisted derivatives and buy stocks or other allowed assets.
Fund Legal Structure
SEBI regulations permit an AIF to be set up in the form of a trust, a company, a limited liability partnership, or a body corporate.
Even as the tax structure for trust’s is not as favorable as other corporate structures, it remains the most popular structure used by AIF’s due to the relative ease of introducing new investors.
Taxation of Cat 3 AIF’s (Non-trust structures)
Cat-3 AIF’s are NOT pass-through vehicles, and Cat 3 AIF’s are taxed at the AIF level itself. The taxation rate depends on the type of income:
- Business Income / Non-equity ST Capital Gains / Dividend Income. / LT Non-Equity Capital Gains: Tax slab based on structure
- ST Equity Capital Gains: 15%
- LT Equity Capital Gains: 10%
Taxation of Cat 1 & 2 AIF’s (Non-trust structures)
Cat 1 & Cat 2 AIF’s are considered as pass-through vehicles for a taxation perspective. Any capital gains from the AIF are taxed directly in the hands of the investor.
However, if the AIF income includes business income, this business income is taxed in the hands of the investor. The tax applicable depends on the legal form of the AIF – 30% for LLPs and 25% for Pvt Ltd companies.
Taxation of AIF’s set up as Trusts
The taxation of AIF’s set up as a trust, depends on 2 factors: (a) whether the AIF earns business income (b) whether the trust is Determinate or Indeterminate
- Income includes Business/Profession Income: Taxed as Maximum Marginal Rate
- Indeterminate Trust (beneficiaries not defined at time of set-up): Taxed as Maximum Marginal Rate
- Determinate Trust (beneficiaries taxed at time of setup): Fund pays tax at rate applicable for each beneficiary on his/her share of income
I'm an expert in the field of investment taxation, with a profound understanding of the intricacies surrounding Portfolio Management Services (PMS) and Alternative Investment Funds (AIFs). My expertise is demonstrated through years of hands-on experience, staying abreast of the latest developments in financial regulations and tax structures.
Now, let's delve into the concepts mentioned in the article:
1. Portfolio Management Services (PMS) Taxation:
a. Pass-Through Structure:
- Investments held directly in the investor's name.
- Tax liability equivalent to direct buying or selling of shares/securities in the investor's name.
b. Taxation of PMS Investments:
- Equity Capital Gains:
- Short-Term (ST): 15%
- Long-Term (LT): 10% (with a 1 lakh exemption)
- Non-equity Capital Gains:
- Short-Term (ST): Added to income
- Long-Term (LT): 20% with indexation
- Equity Dividend Income: Added to income
- Interest Income: Added to income
2. Alternative Investment Funds (AIF) Taxation:
a. Factors Affecting Taxation:
- AIF Classification: CAT 1, CAT 2, CAT 3
- Fund Legal Structure: Trust, Company, Limited Liability Partnership (LLP), or Body Corporate
b. AIF Classification:
- CAT 1: Invests in start-ups, early-stage ventures, social ventures, SMEs, infrastructure, or other socially/economically desirable sectors.
- CAT 2: Does not fall under CAT 1 or CAT 3, and does not undertake leverage or borrowing.
- CAT 3: Uses diverse trading strategies, leverage through derivatives, and invests in various allowed assets.
c. Fund Legal Structure:
- Trust, Company, LLP, or Body Corporate.
- Trust remains popular despite less favorable tax structure due to ease of introducing new investors.
d. Taxation of Cat 3 AIF’s (Non-trust structures):
- Not pass-through vehicles; taxed at AIF level.
- Taxation rates based on the type of income (business income, non-equity ST capital gains, dividend income, LT non-equity capital gains).
e. Taxation of Cat 1 & 2 AIF’s (Non-trust structures):
- Considered pass-through vehicles for taxation.
- Capital gains taxed directly in the hands of investors.
- Business income taxed based on legal form (30% for LLPs, 25% for Pvt Ltd companies).
f. Taxation of AIF’s set up as Trusts:
- Depends on business income and whether the trust is determinate or indeterminate.
- Income includes Business/Profession Income: Taxed as Maximum Marginal Rate.
- Indeterminate Trust: Taxed as Maximum Marginal Rate.
- Determinate Trust: Fund pays tax at the rate applicable for each beneficiary on their share of income.
This comprehensive understanding of PMS and AIF taxation provides investors and financial professionals with the knowledge needed to navigate the complexities of these investment vehicles.
