PMS and AIF Taxation in India: Who Pays What

Taxation is where PMS and AIFs stop looking like fancy mutual funds and start looking like what they legally are: your own investments, or a private trust's investments, wearing a manager's shirt. The differences are not cosmetic. A PMS account is taxed exactly like direct equity because the securities are yours. A Category I or II AIF passes its income through to you with its character intact. A Category III AIF pays tax inside the fund. Getting these wrong — usually by assuming a mutual-fund-like tax slip arrives at year end — is how sophisticated investors end up with April surprises. Here is how each machine actually works, as the law stands on 3 November 2026.

PMS: there is no wrapper, so there is nothing to unwrap

In a PMS, the portfolio manager trades securities held in your demat account, funded from your bank account. Every trade is legally yours, and the tax follows accordingly: there is no fund-level tax, no pass-through section, and no TDS by the manager on your gains. Your capital gains statement from the PMS provider lists each lot, exactly as your broker would. Source: SEBI investor education page on PMS and SEBI (Portfolio Managers) Regulations, 2020, accessed 3 November 2026.

That means the ordinary capital-gains regime applies, as reset by the July 2024 Budget (effective for transfers on or after July 23, 2024):

• Listed equity held more than 12 months: LTCG at 12.5%, with the first ₹1.25 lakh of such gains in a financial year exempt (Section 112A). The exemption is shared across all your equity gains — your PMS stocks, your direct stocks, your equity fund redemptions.
• Listed equity held 12 months or less: STCG at 20% (Section 111A).

Source: Sections 111A and 112A, Income-tax Act, as amended by the Finance (No. 2) Act, 2024 — the same rates our mutual fund taxation post applies to equity funds.

The practical twist: PMS strategies churn. A discretionary manager repositioning through a year realises mostly short-term gains, and 20% STCG on a ₹50 lakh portfolio can quietly outpace what a buy-and-hold index investor pays. Neither manager behaviour nor your fee payments are tax events — fees (which attract 18% GST, cross-checked against PMS fee guides by Altportfunds, September 30, 2026, and Fincart, as no official page was fetchable on 3 November 2026) simply shrink the portfolio before growth compounds. Dividends from PMS-held stocks are taxed at your slab rate, with 10% TDS once your annual dividend income crosses ₹10,000 (Section 194, threshold raised from ₹5,000 with effect from April 1, 2025). Source: Income Tax Department TDS guidance; Bajaj Finserv tax notes.

At filing, you report PMS gains in the same capital-gains schedules you would use for direct equity (most investors use ITR-2; our ITR filing guide walks the form choice), and the TDS on dividends shows up in Form 26AS and AIS.

AIF Category I and II: genuine pass-through, with one exception

Category I (venture capital, SME, social venture, infrastructure, angel funds) and Category II (private equity, private credit) AIFs run on a pass-through design with three moving parts in the Income-tax Act — Sections 115U, 115UB and the exemptions in Section 10(23FBA)/(23FBB):

• At the fund: income other than business income — capital gains, interest, dividends — is exempt (Section 10(23FBA)). The fund does not pay tax on what it earns from investments.
• In your hands: that same income is taxed to you "in the same manner as if" you had made the investments directly (Section 115UB(1)), and it reaches you with the same character and proportion it had in the fund (Section 115UB(3)). So equity gains the fund held over 12 months arrive as 12.5% LTCG (above the ₹1.25 lakh exemption you share with all your equity gains); gains on holdings sold within 12 months arrive as 20% STCG; interest lands at your slab rate under income from other sources; dividends at slab with the fund's TDS as credit. Note the character follows the fund's holding period of the security — your own unit age is irrelevant to that label.
• The exception — business income: if a fund's activity is classified as trading or business (fee income, active trading profits), that slice is taxed inside the fund — Section 115UB(4) charges the fund's non-exempt total income at Finance Act rates if the fund is a company or firm, and otherwise at the maximum marginal rate, which is what applies to trust-structured funds. When that already-taxed business income is distributed, it is exempt in your hands (Section 10(23FBB)) — the design's answer to double taxation.

Source: Sections 115UB and 10(23FBA)/(23FBB), Income-tax Act, 1961 — fetched and quoted from incometaxindia.gov.in on 3 November 2026; the Income-tax Act, 2025 (effective April 1, 2026) restates the same pass-through substance, per cross-checks by TaxTMI (Clause 224 analysis) and Altportfunds' 2026 AIF taxation guide.

Three consequences investors actually feel:

• You are taxed annually, distributed or not. If the fund's income is not paid out during the year, it is deemed credited to you on the last day of that financial year (Section 115UB(6)). A private credit fund that accrues 9% interest and pays out nothing still hands you a tax bill at your slab rate. Plan cash for it.
• A 10% TDS rides on distributions. The fund deducts 10% at source on income paid or credited to a resident unit holder (Section 194LBB), excluding the business-income proportion exempt under 10(23FBB); for non-residents, tax is deducted at the rates in force. The TDS is credit, not final tax — you settle up at filing. Source: Section 194LBB, Income-tax Act, fetched from incometaxindia.gov.in, 3 November 2026.
• Losses mostly stay at the fund. Business losses are carried forward by the fund itself; other losses cannot flow to you for units held under 12 months (Section 115UB(2)) — the Act's guard against harvesting fund losses through short-term units.

Category III: the fund pays, and the structure decides how much

Category III AIFs — the hedge-fund-style, long-short, leveraged strategies — sit outside the pass-through chapter entirely. Section 115UB applies only to Category I and II funds; a Category III fund is taxed like any other entity holding the same assets:

• Trading and business income (most derivatives and high-churn strategies) is taxed at the fund level at the maximum marginal rate — 30% plus surcharge and cess, roughly 42.7% where the trust provisions' representative-assessee MMR applies.
• Genuine capital gains, dividends and non-business interest need not attract blanket MMR: for determinate trusts, the Delhi High Court's July 2025 ruling in Equity Intelligence AIF Trust v. CBDT confirmed character-specific (concessional) rates can apply to eligible capital gains. Funds structured as companies simply pay corporate rates.

Source: AIF Platform's taxation explainer (updated October 31, 2026) and Trilithon's Category III taxation note, cross-checked against each other as on 3 November 2026 — no single official page summarises Category III fund-level taxation; verify the fund's own tax annexure before investing.

What you receive from a Category III fund is post-tax income, and the effective leak depends on the fund's legal form and income mix, not just its gross IRR. Two funds reporting identical 15% gross returns can land very different net figures — which is why the PPM's tax annexure and the fund's structure (determinate trust, company, LLP) belong in your due-diligence, not in a footnote.

The Gift City wrinkle: Category III with pass-through for residents

One route brings Category III back into pass-through territory: funds domiciled in GIFT IFSC. The definition of "investment fund" in Section 115UB expressly includes funds regulated under the IFSCA (Fund Management) Regulations, 2022, so a resident investor in a GIFT City Category III feeder fund is taxed on distributions in the same manner and character as if the investments were made directly — equity gains at the standard capital-gains rates, interest at slab — instead of suffering fund-level MMR. Non-resident investors in qualifying IFSC "specified funds" enjoy a separate exemption on that income under Section 10(23FBC). Source: Section 115UB, Explanation 1(a), Income-tax Act (fetched from incometaxindia.gov.in, 3 November 2026); Khaitan & Co's article on taxation of IFSC funds.

This is why so many Cat III and long-short strategies now launch from GIFT City: for a resident HNI comparing an onshore Category III AIF with a GIFT feeder of the same strategy, the tax arithmetic frequently favours the feeder — structure and fees permitting.

Filing mechanics: what lands in your hands at year end

• From a PMS: a capital-gains statement (lot-wise, with STCG/LTCG splits) and dividend TDS entries in 26AS/AIS. Report like direct equity; the ₹1.25 lakh LTCG exemption shares across everything.
• From a Category I/II AIF: the fund must furnish you — and the tax department — a statement giving the nature of income paid or credited during the year (Section 115UB(7)). Each item goes into the schedule matching its character: capital-gains schedules for gains, income from other sources for interest and dividends, with the 10% TDS (194LBB) as credit. Because income is deemed credited annually (115UB(6)), expect this statement even in years the fund distributes nothing.
• From a Category III AIF: distributions arrive net of fund-level tax; ask the fund for its tax statement and disclose per its character notes — there is no pass-through statement because there is no pass-through.

Source: Section 115UB(6) and (7), Income-tax Act, fetched from incometaxindia.gov.in, 3 November 2026.

One habit worth building: before you invest, ask the manager for a sample year-end tax statement and the fund's tax annexure. The extra 15 minutes tells you whether a 15% headline return is 12% in your hands or 9% — and that, more than any pitch, is the number you are actually buying.

This is educational content, not tax advice; rates apply under the law as it stands on 3 November 2026, with the Income-tax Act, 2025 restating the same substance from April 1, 2026. Confirm your specific case with a chartered accountant.