Fees, Charges and Taxation of PMS Explained

Understand Fees, Charges and Taxation of PMS

Key formulas to remember

Fixed fee

Fixed fee = AUM × fee rate (% p.a.)

Charged regardless of performance. Usually applied on average or opening AUM as the agreement states.

Performance fee with hurdle (fee only on excess)

Performance fee = profit share % × (portfolio gain − hurdle amount)

Hurdle amount = invested capital × hurdle rate. No fee if the gain is at or below the hurdle. This applies when the agreement says fee is on the excess only.

Performance fee with high water mark

Performance fee = profit share % × (current value − high water mark)

Charged only if current value is above the high water mark. The mark is the highest value on which a fee was last charged.

Hybrid fee

Total fee = fixed fee + performance fee

Fixed part is lower than in a pure fixed-fee structure.

Entry load

Entry load = not permitted

A portfolio manager cannot charge an entry load to clients.

Equity capital gains rates (listed equity shares, STT paid)

Short term (held up to 12 months): 20%. Long term (held over 12 months): 12.5% on gains above ₹1,25,000 in a year

Plus applicable surcharge and cess. These are the rates for transfers on or after 23 July 2024, as per the Finance Act in force. Rates may change in later Finance Acts, and exam questions follow the current workbook. They apply only to listed equity shares on which STT is paid. Other assets that a PMS may hold, such as debt, unlisted shares and units, have different holding periods and rates. Gains may be treated as business income instead, depending on the facts.

Dividend and interest

Taxed at the client's slab rate

Taxed under Income from Other Sources in the client's hands.

How to solve Fees, Charges and Taxation of PMS questions

1. 1Identify what is asked: fee type, fee calculation, other charge, or tax treatment.
2. 2If it is about fee type, match the key words: fixed means a set percentage regardless of returns, performance means a share of profits, hybrid means both.
3. 3For a performance fee, check whether a hurdle rate and a high water mark apply. Apply the hurdle first, then compare with the high water mark.
4. 4Compute the fee base carefully: gain over the hurdle or over the high water mark, not the total profit unless the question says so.
5. 5For a charges question, remember who pays: the client bears brokerage, custody, audit and statutory costs. Entry load is not allowed.
6. 6For tax, ask who owns the securities. In PMS the client does, so the client is taxed directly, by holding period and type of income.
7. 7Check the answer against the trap options: totals instead of excess, pooled-fund tax, or entry load allowed.

Quickest way: Three-check shortcut

Common mistakes in Fees, Charges and Taxation of PMS

• Charging the performance fee on the whole profit when a hurdle applies on the excess only.

  Students multiply the profit share by total gain and skip the hurdle step.

  Fix: Always subtract the hurdle amount first when the agreement charges only on returns above the hurdle.

• Treating the high water mark as the initial investment amount.

  The two are the same only in the first period, so students assume they always match.

  Fix: The mark is the highest value on which a fee was charged. After a fee year it moves up and stays there if the value falls.

• Thinking the client pays no fee in a loss year, so a fixed fee is also waived.

  Students mix up fixed and performance fees.

  Fix: A fixed fee is payable regardless of returns. Only the performance fee depends on profit.

• Saying an entry load can be charged.

  It is confused with mutual fund practice or with other upfront charges.

  Fix: Remember that entry load is not permitted for portfolio managers. Only expenses and fees disclosed in the agreement can be charged.

• Believing the PMS pays tax on behalf of all clients as a fund.

  Students assume PMS works like a mutual fund scheme.

  Fix: In PMS the securities are in each client's name. Each client is taxed on their own gains, dividend and interest.

• Applying one capital gains rate for all holding periods.

  Students memorise a rate without the holding period test.

  Fix: Check the asset first. For listed equity shares with STT paid, up to 12 months is short term and over 12 months is long term. Then apply the matching rate. Debt, unlisted shares and units have different holding periods and rates.

Worked examples