NISM Series XXI-B Short Notes – Part 5: Taxation & Regulatory Aspects of Portfolio Management

NISM Series XXI-B Short Notes – Part 5: Taxation & Regulatory Aspects of Portfolio Management

This is Part 5 of our 10-part NISM XXI-B short notes series on PassNISM.in. This part covers Chapters 10 and 11 — Taxation and the Regulatory, Governance & Ethical framework for portfolio managers in India. These chapters carry high exam weightage, particularly SEBI PMS Regulations 2020.

👉 Also Read: Part 4: Operational Aspects of PMS & Portfolio Management Process | Free Mock Test

Chapter 10: Taxation Basis of Tax Liability

An investor's income tax liability in India is computed on the basis of their Total Income. What qualifies as total income depends heavily on the individual's residential status — not their citizenship.

Residential Status Categories For Individuals:

• Ordinary Resident in India
• Resident but Not Ordinarily Resident (RNOR)
• Deemed Resident
• Non-Resident

Resident individuals and HUFs are further classified as:

• Resident and Ordinarily Resident (ROR)
• Resident but Not Ordinarily Resident (RNOR)

The residential status of an individual is determined based on the provisions of Section 6 of the Income Tax Act, 1961.

For HUFs:

The residential status of a HUF depends on its place of control and management, and the residential status of its manager (Karta).

For Companies:

• Indian Company
• Foreign Company
• Also applicable to Firms, AOP, BOI, Local Authorities, and Artificial Juridical Persons

Capital Gains vs Business Income (Important Distinction)

Gains from the transfer of securities can be treated as either Capital Gains or Business Income, depending on whether the securities were held as a capital asset or as stock-in-trade (trading asset). This classification has significant tax implications for PMS portfolios.

Five Heads of Income (Under Income Tax Act, 1961)

Other Income Types in PMS Context

• Dividend Income: Income received from equity holdings
• Interest Income: Income from fixed income securities, bonds, deposits
• Business Income: If securities are treated as stock-in-trade

📌 STCG vs LTCG: The classification of gains as short-term or long-term depends on the holding period of the asset. Tax rates differ for each — always check the current rates under the Income Tax Act or SEBI-mandated disclosures.

Chapter 11: Regulatory, Governance & Ethical Aspects of Portfolio Managers Prevention of Money Laundering Act, 2002 (PMLA)

PMLA forms the core of India's legal framework to prevent money laundering. Provisions came into force on July 1, 2005. The objective of PMLA is to prevent money laundering and enable confiscation of property derived from or involved in money laundering activities. Portfolio managers are obligated to report suspicious transactions to FIU-India (Financial Intelligence Unit).

SEBI (Prohibition of Insider Trading) Regulations, 2015

Trading or dealing in securities based on non-public (unpublished) information gives insiders an unfair advantage and damages market integrity. To protect market fairness, SEBI has enacted the Prohibition of Insider Trading Regulations.

Key principle: Any person in possession of unpublished price-sensitive information (UPSI) must not trade in the relevant securities until the information becomes public.

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

These regulations prohibit fraudulent, unfair, and manipulative trade practices in the securities market. Under Regulation 2(1)(c), fraud is defined as any act, expression, omission, or concealment committed to induce another person or their agent to deal in securities.

SEBI (Portfolio Managers) Regulations, 2020 – Summary

This is the primary regulatory framework governing PMS in India. Key elements:

Important Definitions

• Portfolio: A collection of securities/assets managed by a portfolio manager on behalf of a client.
• Principal Officer: The person responsible for the overall operations and compliance of the portfolio manager entity.

Key Regulatory Requirements

Do's and Don'ts for Portfolio Managers (SEBI PMS Regulations)

Key prohibited behaviors include:

• Funds of clients must not be parked in unauthorized institutions (e.g., cooperative banks not in the SEBI-approved list)
• Client portfolio information must not be disclosed to any third party except as permitted under SEBI regulations
• Portfolio manager cannot act against client interests in transactions

Code of Conduct for Portfolio Managers

The Code of Conduct for portfolio managers is specified in Schedule III of the SEBI PMS Regulations. It covers standards of integrity, independence, transparency, and client-first behavior that all registered portfolio managers must adhere to.

Eligible Fund Managers (EFMs)

• Overseas funds availing fund management services from India-based managers are designated as Eligible Investment Funds.
• The India-based manager providing such services is designated as an Eligible Fund Manager (EFM).
• One of the conditions for a fund manager to become an EFM is registration with SEBI under specified regulations.

Research Objectivity (Best Practices)

Independence and objectivity of investment analysts is critical for investor confidence. Key principles:

• The best interests of the investing client must always come before the interests of investment professionals or their firms.
• Every investment professional is personally responsible for maintaining their independence and objectivity when preparing research reports, making investment recommendations, and taking investment action.

Soft Dollar Practices

Investment management firms pay brokerage commissions for trade execution. Soft dollar arrangements occur when a portfolio manager pays a higher commission to a brokerage firm in exchange for additional services (research reports, hardware, software, or non-research services).

📌 Important: Since the investor bears the brokerage cost in PMS, soft dollar arrangements are considered abusive and must be avoided. Full transparency about services availed and charges paid is required.

Quick Revision Box – Part 5

• Tax liability depends on residential status, not citizenship
• Gains can be capital gains or business income — depends on how securities were held
• Five heads of income: Capital Gains, Salary, House Property, Business, Other Sources
• PMLA provisions came into force: July 1, 2005
• SEBI PMS Regulations 2020 = primary regulatory framework for PMS
• Compliance Officer must report non-compliance independently to SEBI
• Soft dollar arrangements are abusive — avoid them
• PMS must not disclose client info to third parties (except as per regulations)

👉 Continue Reading: Part 6: Indices, Market Efficiency & Behavioural Finance

👉 Practice Now: NISM XXI-B Free Mock Test

👉 Explore: SEBI Portfolio Managers Regulations Guide