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NISM Series XXI A PMS Short Notes – Chapter 11 & 12: Taxation and Regulatory, Governance & Ethical Aspects

12 Apr 2026 • NISM-Series-21A: Portfolio Management Services (PMS) Distributors Mock Tests

NISM Series XXI A PMS Short Notes – Chapter 11 & 12: Taxation and Regulatory, Governance & Ethical Aspects

Welcome to Part 7 of 7 — the final chapter in our complete NISM Series XXI A – PMS Distributors Exam study series. This post covers:

  • Chapter 11: Taxation
  • Chapter 12: Regulatory, Governance and Ethical Aspects of Portfolio Managers

These are compliance and regulatory chapters that are regularly tested in the NISM XXI A PMS certification exam with definition-based and scenario-based questions.

📖 Previous Parts: Part 1 | Part 2 | Part 3 | Part 4 | Part 5 | Part 6

Table of Contents

  1. Residential Status of Investors
  2. Taxability Based on Residential Status
  3. Capital Gains Taxation
  4. Indexed Cost of Acquisition
  5. Dividend and Interest Taxation
  6. Prevention of Money Laundering Act (PMLA), 2002
  7. SEBI Prohibition of Insider Trading Regulations 2015
  8. SEBI Prohibition of Fraudulent and Unfair Trade Practices
  9. SEBI (Portfolio Managers) Regulations 2020
  10. Soft Dollar Practices
  11. Practice Questions

Chapter 11: Taxation 1. Residential Status — Why It Matters for Taxation

Under the Indian Income Tax Act, an investor's tax liability is calculated based on their Total Income. What is included in this total income depends on the investor's residential status — not their citizenship.

An individual's residential status under Section 6 of the Income Tax Act is classified as:

Category Description
Ordinary Resident in India (ROR) Physically present in India for required number of days and has been resident for prior years as well
Resident but Not Ordinarily Resident (RNOR) Meets basic residency requirement but not the additional conditions
Deemed Resident Indian citizen not taxable in any country — deemed to be Indian resident
Non-Resident (NR) Does not meet residency conditions — limited Indian tax liability

Residential Status for Companies

  • Indian Company: Incorporated in India, or whose place of effective management is in India
  • Foreign Company: Not incorporated in India and effective management is outside India

2. Taxability Based on Residential Status

Source of Income Resident (ROR) Resident but Not Ordinarily Resident (RNOR) Non-Resident (NR)
Income received in India Taxable Taxable Taxable
Income accruing in India Taxable Taxable Taxable
Income from business controlled in India (accruing outside) Taxable Taxable Not Taxable
Income from business outside India (accruing outside India) Taxable Not Taxable Not Taxable

 

Key Principle: Residential status determines the scope of total income. Citizenship has no relevance to Indian tax liability.

3. Capital Gains Taxation

Any profit arising from the transfer of a capital asset is taxable under the head "Capital Gains" in the year in which the transfer occurs.

However, not every transfer gives rise to taxable capital gains. Exceptions include:

  • Transactions not treated as "transfer" under Section 47 of the Income Tax Act
  • Assets excluded from the definition of a capital asset

Short-Term vs Long-Term Capital Gains

Asset Type Holding Period for LTCG STCG Tax Rate LTCG Tax Rate
Listed Equity Shares / Equity MF More than 12 months 20% (Section 111A) 12.5% above ₹1.25 lakh exemption (Section 112A)
Debt Mutual Funds / Bonds More than 24 months As per applicable slab rate As per applicable slab rate (indexation removed)
Real Estate More than 24 months Slab rate 12.5% (without indexation from FY2024-25 budget)
Unlisted Shares More than 24 months Slab rate 12.5% without indexation

Note: Tax rates above are indicative based on NISM curriculum framework. Always refer to the current Finance Act for applicable rates as they are subject to annual budget changes.

4. Indexed Cost of Acquisition

Indexation adjusts the cost of acquisition for inflation, reducing taxable capital gains on long-term assets (applicable where indexation benefit is available).

Two-Step Calculation

  1. Step 1: Calculate the original cost of acquisition
  2. Step 2: Multiply by the ratio of CII (Cost Inflation Index) values:

Indexed Cost = Cost of Acquisition × CII of Transfer Year ───────────────────────────────────────── CII of Year of Acquisition (or 2001-02, whichever is later)

The Cost Inflation Index (CII) is published annually by the Central Government to reflect inflation in asset prices.

5. Taxation of Dividend and Interest Income Dividend Income

  • Dividend income from securities is taxable in the hands of the recipient
  • Taxed under the head: "Income from Other Sources"
  • Since the abolition of DDT (Dividend Distribution Tax) in 2020, dividends are fully taxable at the investor's applicable slab rate

Interest on Securities

  • Interest income from securities (bonds, debentures, G-Secs) is taxable under the head "Income from Other Sources"
  • Exception: If the interest is received in the course of carrying on a business, it is classified as business income

Chapter 12: Regulatory, Governance and Ethical Aspects 6. Prevention of Money Laundering Act (PMLA), 2002

The Prevention of Money Laundering Act (PMLA), 2002 forms the core of India's legal framework to combat money laundering.

  • PMLA provisions came into force on July 1, 2005
  • Objective: To prevent money laundering and provide for confiscation of property derived from or involved in money laundering

Obligations of Portfolio Managers Under PMLA / AML Guidelines

  • Maintain records of all transactions
  • Perform KYC (Know Your Customer) for all clients
  • Report suspicious transactions to the Financial Intelligence Unit (FIU-IND)
  • Appoint a Principal Officer responsible for AML compliance
  • Train employees on AML/CFT (Combating Financing of Terrorism) procedures

What Constitutes Money Laundering?

Money laundering is the process of making illegally obtained funds appear legitimate by passing them through a complex sequence of transactions. It typically involves three stages:

  1. Placement: Introducing illicit funds into the financial system
  2. Layering: Concealing the trail through complex transactions
  3. Integration: Reintroducing the funds as apparently legitimate

7. SEBI (Prohibition of Insider Trading) Regulations, 2015

Insider trading refers to trading in securities by someone who possesses Unpublished Price Sensitive Information (UPSI) — information not available to the general public that could, if known, materially affect the stock price.

Why is Insider Trading Prohibited?

  • It gives insiders an unfair advantage over regular investors
  • It undermines market integrity and fairness
  • It violates the principle of equitable markets

Who is an "Insider"?

  • Directors, promoters, key management personnel
  • Employees with access to price-sensitive information
  • Connected persons (advisers, auditors, family members) who receive UPSI

Examples of UPSI

  • Quarterly financial results before public announcement
  • Mergers, acquisitions, or demergers not yet announced
  • Dividend declaration decisions
  • New orders or contract wins not publicly disclosed

SEBI Insider Trading Regulations 2015 — Key Provisions

  • Trading window closure during sensitive periods (before results)
  • Maintenance of structured digital database of UPSI recipients
  • Pre-clearance requirements for trading by designated persons
  • Mandatory reporting of trades by insiders

8. SEBI (Prohibition of Fraudulent and Unfair Trade Practices) Regulations, 2003

These regulations prohibit fraudulent, unfair, and manipulative trade practices in securities markets.

Definition of Fraud (Regulation 2(1)(c))

Fraud includes any act, expression, omission, or concealment committed to induce another person or their agent to deal in securities — whether or not there is wrongful gain or loss involved.

Examples of Prohibited Activities

  • Price manipulation: Creating artificial price movements to mislead investors
  • Front running: Trading ahead of a client order using advance knowledge
  • Circular trading / Wash trades: Buying and selling to create false volume or price appearance
  • Mis-selling: Selling unsuitable products to investors with misleading information
  • Pump and dump: Artificially inflating prices to sell at a profit
  • False or misleading statements about securities

9. SEBI (Portfolio Managers) Regulations, 2020

These regulations govern all portfolio management service providers registered with SEBI. Key provisions include:

Registration Requirements

  • Portfolio managers must register with SEBI before commencing operations
  • Must maintain a net worth as specified by SEBI
  • Principal officer must have relevant qualifications and experience

Code of Conduct for Portfolio Managers

  • Act in the best interest of clients at all times
  • Maintain high standards of integrity and fairness
  • Avoid conflicts of interest
  • Provide full and fair disclosure to clients
  • Ensure that investment decisions are based on client's goals and risk profile
  • Maintain confidentiality of client information
  • Not enter into any transaction against the interest of the client

Obligations Regarding Client Reporting

  • Provide performance reports to clients at least once every quarter
  • Reports must include portfolio holdings, transactions, and performance metrics
  • Audited annual report must be provided to each client

10. Soft Dollar Practices — What Are They and Why Are They Problematic?

Soft dollar arrangements occur when investment management firms pay higher-than-necessary brokerage commissions to brokerage firms in exchange for receiving additional services — such as research reports, hardware, software, or even non-research-related services.

Why Are Soft Dollars a Problem?

Issue Explanation
Cost burden on investor In PMS, brokerage is charged to the client — so excess commissions are effectively paid by the investor
Conflict of interest PM may choose a more expensive broker for self-benefit rather than in the client's best interest
Lack of transparency Clients are unaware that they are indirectly paying for the PM's research tools or other services

SEBI's Stance on Soft Dollars

  • Soft dollar arrangements are considered abusive and must be avoided
  • There must be complete transparency regarding services availed and charges paid
  • Portfolio managers must always seek best execution for their clients — choosing brokers based on execution quality, not kickback services

Practice Questions — Chapters 11 & 12

  1. Under the Income Tax Act, an investor's tax liability is based on:

    a) Citizenship   b) Residential Status   c) Age   d) Annual Income

    ✅ Answer: b) Residential Status

  2. PMLA came into force on which date?

    a) January 1, 2003   b) April 1, 2004   c) July 1, 2005   d) March 1, 2006

    ✅ Answer: c) July 1, 2005

  3. Insider trading is defined as trading based on:

    a) Technical analysis   b) Unpublished Price Sensitive Information (UPSI)   c) Analyst recommendations   d) Historical price data

    ✅ Answer: b) UPSI

  4. Soft dollar arrangements are problematic because:

    a) They reduce brokerage costs   b) They eliminate conflicts of interest   c) Clients indirectly bear excess brokerage for the PM's benefit   d) They increase portfolio performance

    ✅ Answer: c)

  5. Dividend income received from securities is taxed under which head?

    a) Capital Gains   b) Salaries   c) Income from Other Sources   d) Business Income

    ✅ Answer: c) Income from Other Sources

  6. The SEBI Regulation that prohibits manipulation, fraud and unfair trade practices is:

    a) SEBI (Insider Trading) Regulations 2015   b) SEBI (PFUTP) Regulations 2003   c) PMLA 2002   d) SEBI (PM) Regulations 2020

    ✅ Answer: b) SEBI (PFUTP) Regulations 2003

Key Takeaways — Chapters 11 & 12 at a Glance

  • Tax liability = based on Residential Status, NOT citizenship
  • Residential categories: ROR, RNOR, Deemed Resident, Non-Resident
  • Capital gains on transfer of capital assets — STCG (short-term) or LTCG (long-term)
  • Indexed Cost of Acquisition = Original Cost × (CII of Transfer Year ÷ CII of Acquisition Year)
  • Dividend & interest = Taxable under "Income from Other Sources"
  • PMLA 2002 = Core AML law; came into force July 1, 2005
  • SEBI Insider Trading Regulations 2015 = Prohibits trading on UPSI
  • SEBI (PFUTP) Regulations 2003 = Prohibits fraud, manipulation, unfair trade practices
  • SEBI PM Regulations 2020 = Governs PMS industry — code of conduct, registration, reporting
  • Soft dollar = Must be avoided — abusive and against client interest

Complete Series — All 7 Parts of NISM XXI A PMS Short Notes

Part Chapter(s) Link
Part 1 Chapter 1: Investments Read Now →
Part 2 Chapters 2 & 3: Securities Markets & Stocks Read Now →
Part 3 Chapters 4 & 5: Fixed Income & Derivatives Read Now →
Part 4 Chapters 6 & 7: Mutual Funds & Portfolio Managers Read Now →
Part 5 Chapter 8: Operational Aspects of PMS Read Now →
Part 6 Chapters 9 & 10: Portfolio Process & Performance Read Now →
Part 7 Chapters 11 & 12: Taxation & Regulatory Aspects You are here ✅

Start Your NISM XXI A Exam Preparation Today

 

These short notes are prepared in original language for educational purposes to assist aspirants of the NISM Series XXI A – PMS Distributors Certification Examination. For official content, refer to the NISM workbook available at certifications.nism.ac.in.

Tags: NISM Series XXI A, NISM PMS certification, taxation capital gains, SEBI portfolio managers regulations 2020, PMLA 2002, insider trading SEBI, soft dollar practices, SEBI fraudulent trade practices, nism study material, nism exam registration, portfolio management services India