Mutual funds outshine PMS in tax efficiency, as PMS investors face immediate taxation on gains from stock transactions
Mutual Funds and Portfolio Management Service (PMS) are twopopular methods by which an investor can invest in an expert curated portfolio.While both have their distinctive features in terms of ticket size, costs,transparency, taxation, etc, what matters the most, for the investor, is themoney received in hand i.e. post-tax returns. Hence, it is critical tounderstand the taxation aspect of mutual funds and PMS in detail.
Let us understand with an example. Suppose, in April 2021 Deeptiinvested Rs 50 lakh in mutual fund A and was allotted 50,000 units at Rs 100per unit. The fund manager further invested in a diversified portfolio of 25stocks. During the year 2021-22 the fund manager sold stock X and invested theamount in stock L. As on March 31, 2022, the NAV of the mutual fund unit is Rs105 per unit.
As mutual funds are having tax pass through status, investment inmutual fund is taxed only when the investor sells the units and not when anyactivity is undertaken by the fund manager or the NAV changes. Since Deeptihasn’t sold her investment in mutual fund A there would be no tax implicationfor FY 2021-22.
Let’s assume that Deepti sold her investment in mutual fund A inMay 2022 and received redemption amount of Rs 55 lakh. Rs 5 lakh (sale value Rs55 lakh less cost of Rs 50 lakh) will be Long Term Capital Gain (LTCG) as it isheld for a period of more than one year. LTCG tax of Rs 41,600 will be payableon sale of mutual fund A by Deepti.
In April 2021 Pramila invested Rs. 50 lakh in PMS B and thePMS manager further invested in a diversified portfolio of 25 stocks. Duringthe year 2021-22 the PMS manager sold stock Y for Rs. 7.5 lakh which waspurchased for Rs. 5 lakh. Fund manager invested the same amount of Rs. 7.5 lakhin stock M. Unlike mutual fund, in a PMS the stocks are purchased and sold fromthe demat of the investor. Hence, it will be taxed as short capital gain for FY2021-22 and Pramila will pay tax of Rs. 39,000 on the capital gain of Rs 2.5lakh (sale value of Y Rs 7.5 lakh less cost of Y Rs 5 lakh).
Let’s assume, that fund manager of PMS sold investment in stock Mfor Rs 10 lakh in May 2022 and invested the same amount in stock N. Again,Pramila will pay short term capital gain tax of Rs 39,000 on the capital gainof Rs 2.5 lakh (sale value of M Rs 10 lakh less cost of M Rs 7.5 lakh).
| Deepti (In mutual fund) | Pramila (In PMS) | |
| Invested | 50 lakh | 50 lakh |
| Pre-tax returns | 5,00,000 | 5,00,000 |
| Tax paid | 41,600 | 78,000 (39,000 for each FY2021-22 and FY 2022-23) |
| Post-tax returns | 4,58,400 | 4,22,000 |
As seen in the above example, Deepti who invested in mutual fundhas got post tax returns of Rs 4,58,400 whereas Pramila who invested in PMS hasgot post tax returns of Rs 4,22,000. Deepti got a higher post tax return thanPramila just by choosing a more tax effective investment instrument.
One also needs to take cognisance of the fact that if there arenumerous or frequent transactions of stocks or future and options trading,then, instead of being treated as capital gains, the PMS activity may beconsidered as income from business of the assesses and taxed accordingly.
(The writer is a Chartered Accountant andfounder of Nimit Consultancy, a boutique investment and tax consultancy firmhaving global clientele)
