AIF vs PMS Taxation: Which Structure Keeps More After Tax?

Many equity managers now offer the same strategy in two wrappers: a portfolio management service (PMS) and an alternative investment fund (AIF). The stocks can be nearly identical. The tax is not, because the law looks at who owns the securities and what kind of income they produce.

Most PMS vs AIF taxation write-ups stop at one line: PMS is taxed in your hands, Category III is taxed at "42.7%". That line is wrong often enough to mislead. A Category III AIF that holds listed shares for the long term can pay about 14.95% on its gains. A high-churn PMS can cost you 23.92% on most of its return.

This guide compares the three regimes on rate, timing, loss set-off, compliance and the post-tax returns of three strategy types. It covers resident individuals and onshore funds set up as trusts, under the Income-tax Act, 2025, which has applied since 1 April 2026. Old section numbers are given alongside the new ones.

The stakes are large. SEBI's AIF data shows Category III AIFs alone had commitments of ₹3,37,192 crore at 30 June 2026.

The three regimes were not designed together.

• PMS: no special regime at all. A portfolio manager runs your money in your own demat account. Tax law has no PMS section because the investor is simply a person selling shares. The SEBI (Portfolio Managers) Regulations, 2020 set the minimum at ₹50 lakh and bar the manager from using derivatives to leverage a client's portfolio.
• 2015: pass-through for Category I and II. The Finance Act, 2015 created a special regime for these funds. The government's memorandum to the Finance Bill, 2015 said pooled vehicles "other than hedge funds" making passive investments had been given pass-through in other countries. Category III, the hedge-fund category, was left out.
• Category III: general trust law. With no section of its own, a Category III AIF set up as a trust is taxed through its trustee under private-trust rules.
• 2019: two changes. A higher surcharge pushed the rate on a long-short fund's business income to 42.7% from 35.9%, the source of the well-known figure. Non-business losses of Category I and II funds were also allowed to pass through.
• July 2024: new capital gains rates. Short-term gains on listed equity moved from 15% to 20% and long-term gains from 10% to 12.5%, with the annual exemption raised to ₹1.25 lakh.
• 2025: two clarifications. The Finance Act, 2025 said securities held by Category I and II funds are capital assets. In July 2025 the Delhi High Court ruled that a Category III AIF is not an "indeterminate" trust merely because its investors are not named in the trust deed.
• April 2026: renumbering. The Income-tax Act, 2025 came into force on 1 April 2026 and changed every section number in this debate.

The mapping follows the ICAI tabulation of April 2026.

PMS taxation is direct-equity taxation with someone else pressing the buttons. You are the legal owner of every share, so each sale the manager makes is your sale.

• Short-term capital gains (STCG): shares sold within 12 months are taxed at 20% under section 196 of the Income-tax Act, 2025.
• Long-term capital gains (LTCG): shares held longer are taxed at 12.5% on gains above ₹1.25 lakh a year under section 198. These rates have applied since 23 July 2024.
• Dividends and interest: taxed at your slab rate.
• Surcharge and cess: surcharge depends on your total income, but on dividends and on these capital gains it cannot exceed 15%. A 4% cess applies on top.

That gives the effective rates below for tax year 2026-27.

Dividends for the top row are taxed at 35.88% because the 15% surcharge cap applies to them.

The manager's turnover decides how much of your return is short-term. A portfolio that replaces most of its holdings within a year turns a 12.5% problem into a 20% one. It also brings the tax forward, because gains you would otherwise have left unrealised are taxed this year.

Gains from frequent trading can be assessed as business income instead of capital gains, depending on the volume, frequency and holding period of trades. A CBDT circular of 2016 lets taxpayers treat gains on listed shares held for more than 12 months as capital gains without dispute, as long as they stay consistent.

Derivatives are different. Profit from exchange-traded futures and options is generally treated as non-speculative business income, taxed at your slab rate and reported in ITR-3. Whether PMS fees can be deducted from capital gains is disputed; that is a subject for a separate post.

Category I and II AIFs are venture, infrastructure, private equity, private credit and similar funds. Section 224 gives them pass-through status, which is where most PMS vs AIF tax confusion starts.

The law taxes you "in the same manner as if" you had made the fund's investments directly.

• Character is retained. A long-term gain in the fund is a long-term gain for you. Interest is interest. Your own slab, surcharge tier and ₹1.25 lakh exemption apply.
• Business income stays in the fund. It is taxed there at the maximum marginal rate when the fund is a trust, and it is then exempt in your hands.
• Gains on securities are capital gains by statute. Since the Finance Act, 2025, securities held by these funds are capital assets, which removes the argument that an active fund's share sales are business income.

One caution on scope. A Category II fund must invest primarily in unlisted securities, so you will rarely find a listed-equity PMS strategy offered as a pass-through fund. Unlisted shares also have a 24-month holding period for long-term treatment, and short-term gains on them are taxed at your slab rate.

The fund deducts 10% TDS when it pays or credits income to a resident investor. That is a credit against your final tax, not the tax itself. If the income is interest and you are in the top bracket, your liability is 39%, and the remaining 29 percentage points are yours to pay through advance tax.

A Category III AIF may use leverage, derivatives and short positions. It has no pass-through. If it is a trust, which most are, the trustee is assessed as a "representative assessee" and the fund pays tax before returns reach you. The NAV you see is normally after that tax.

The Act says the trustee is taxed "in like manner and to the same extent" as the beneficiaries would be. Two exceptions push the rate to the maximum marginal rate:

1. Indeterminate shares. If the beneficiaries' shares are not known, all income is taxed at the maximum marginal rate. The Delhi High Court's July 2025 ruling in the Equity Intelligence AIF Trust case held that a fund is not indeterminate just because investors are not named in the trust deed.
2. Business income. Even in a determinate trust, business profits are taxed at the maximum marginal rate. Derivatives profit usually falls here. Frequent share trading can too.

So the fund has two possible tax profiles.

Unlike Category I and II funds, a Category III fund has no statutory rule saying its securities are capital assets. Whether its share gains are capital gains or business income turns on the facts.

The maximum marginal rate is the highest slab rate plus surcharge. Under the default tax regime the top surcharge is 25%, which gives 30% × 1.25 × 1.04 = 39%. Under the old regime the top surcharge is 37%, which gives 42.744%. Advisers differ on which applies to a fund, and a Mumbai tribunal Special Bench held in April 2025, in a private trust case, that surcharge should be graded by the level of income. Ask the manager which rate the fund actually provides for.

The timing of tax matters as much as the rate, because tax paid earlier stops compounding.

• None of the three defers tax on realised gains. In a mutual fund, churn inside the scheme is tax-free and you pay only on redemption. Not so here. In all three structures a gain is taxed in the year the manager realises it.
• Pass-through can tax you before you are paid. Section 224 says income the fund has earned but not distributed is "deemed to have been credited" to you on the last day of the tax year. You can owe tax on income still sitting in the fund. It is not taxed again when it is eventually paid.
• Category III tax comes out of the fund. You do not write a cheque. The cost shows up as a lower NAV instead of a tax payment.

Rates look similar across structures. The treatment of losses does not.

PMS. A loss on a share sold in your account is your loss. Under sections 108 to 111:

• a short-term capital loss can be set off against any capital gain, short-term or long-term, from any source, including property or mutual funds;
• a long-term capital loss can be set off only against long-term gains;
• a capital loss cannot be set off against salary, business or other income;
• what is left can be carried forward for up to eight tax years, subject to the return-filing conditions.

Category I and II AIF. Non-business losses pass through to you, with one condition: the loss is ignored if it arose on a unit you had not held for at least twelve months. The fund's business losses never pass through. They stay in the fund and are carried forward there.

Category III AIF. There is no provision that passes a Category III fund's losses to its investors. Losses stay inside the fund's own computation and can only reduce the fund's future income. Your personal losses cannot reduce the fund's tax either. In a poor year you carry the economic loss but get no tax loss to use elsewhere.

For an investor who regularly books gains elsewhere, this is often the largest practical difference in AIF vs PMS taxation.

A PMS gives you the most control and the most work.

• Advance tax. If your tax due for the year is ₹10,000 or more, it is payable in four instalments: 15% by 15 June, 45% by 15 September, 75% by 15 December and 100% by 15 March. PMS gains are not known in advance, so the law gives some relief: no interest is charged on a shortfall caused by underestimating capital gains or dividends, provided the tax on that income is paid in the remaining instalments or by 31 March.
• Return form. ITR-2 if you have no business income, ITR-3 if you do, which includes derivatives income.
• Volume. Every trade must be reported. A 2024 Moneycontrol report quoted a PMS chief investment officer saying that an HNI with "five to seven different PMS strategies", each with 30 to 40% churn, ends up with a very high number of transactions at filing time.

Portfolio managers send a capital gains statement after year-end. Pass-through funds issue an annual statement of income by head (Form 64C under the earlier rules, reported as Form 78 under the Income-tax Rules, 2026). The department's ITR-2 guidance has a dedicated Schedule PTI for pass-through income.

For a Category III AIF, do not assume there is nothing to report. The law allows the department to assess either the trustee or the beneficiary, so keep the fund's tax note and show it to your adviser.

The scenarios below hold the gross return constant and change only the structure and the kind of income. They are illustrations, not forecasts.

• ₹1 crore invested for five years at 12% a year before tax. Fees and costs are ignored and assumed equal.
• Gross value after five years with no tax: ₹176.23 lakh.
• Investor A is a resident individual in the default regime with total income above ₹2 crore: 14.95% on LTCG, 23.92% on STCG, 39% on slab income.
• Investor B has total income between ₹50 lakh and ₹1 crore: 14.3%, 22.88% and 34.32%.
• The Category III fund is a trust that provides for tax at the top surcharge tier and does not use the ₹1.25 lakh exemption.
• Tax is paid out of the investment, and no second tax is assumed when Category III units are redeemed.
• The pass-through rows show the arithmetic only. A listed-equity strategy is rarely available in a Category I or II fund.

All gains are long-term and realised at the end of year five.

On the common reading after the 2025 High Court ruling, the fourth row is the relevant one, and the gap to a PMS is under ₹20,000 on ₹1 crore over five years. The last row shows what is at stake if a fund is treated as indeterminate or its gains as business income.

Each year's 12% return is fully realised: 70% as short-term gains and 30% as long-term gains.

Churn costs every structure about a percentage point a year against Strategy 1. The PMS keeps a small edge from the yearly ₹1.25 lakh exemption. The real risk sits in the last two rows: the more a fund trades, the stronger the case for treating its profits as business income. A PMS investor faces the same question at very high frequency, but at the investor's own rate.

The whole return is derivatives and trading profit, taxed every year as business income.

A PMS is not a like-for-like alternative here. Portfolio managers cannot leverage client portfolios through derivatives, so between these two wrappers a true long-short strategy lives in the AIF. The two "earned directly" rows show the tax if the same income reached you at your own rate. For a top-bracket investor the fund's 39% is no worse. For anyone below the top bracket, the fund's flat maximum marginal rate is a cost.

• Structure matters far less than the character of the income. Capital gains are taxed at 14.95% to 23.92% in every wrapper. Business income is taxed at 39% or more.
• A Category III AIF is close to tax-neutral against a PMS for long-only equity at the top bracket, and clearly worse only when business-income treatment or a lower investor bracket comes into play.

• PMS: your own rate. The tax follows your surcharge tier, your ₹1.25 lakh exemption and your regime. An investor below the top tier pays less than a fund providing at the top tier.
• PMS: usable losses. Losses are yours to set off against other capital gains and to carry forward for eight years.
• PMS and pass-through: no character risk on shares held long term. Listed shares held beyond 12 months can be treated as capital gains without dispute, and Category I and II funds have a statutory capital-asset rule.
• Category I and II: pass-through with one statement. You get your own rates on capital gains and interest, with the fund doing the computation.
• Category III AIF: tax handled for you. The fund computes and pays, which removes most trade-level reporting.
• Category III AIF: parity at the top. If you already pay the capped 15% surcharge, a determinate long-only fund pays the same headline rates on gains that you would.
• All three: the 15% cap. Surcharge on listed-equity gains and dividends stops at 15% however large the income.

This makes the choice easier than headline rates suggest. Decide on strategy, liquidity and ticket size first, then check whether the tax line changes the answer.

PMS Sahi Hai is a comparison platform for PMS and AIF strategies, and it is worth being exact about what it does and does not do on tax.

What you can use today

• A one-year tax example. The PMS and AIF tax explainer taxes a ₹1 crore year line by line. It shows the same ₹13 lakh of PMS gains costing ₹1,52,750 if all long-term and ₹2,70,400 if all short-term. Read it next to Strategy 1 and Strategy 2 above.
• The PMS mechanics in detail. Our earlier post on how PMS gains are taxed in your own hands covers holding periods for listed shares, unlisted shares and debt.
• Side-by-side strategy comparison. The compare page lists PMS, AIF and GIFT City strategies with filters for product class, category, fund house and benchmark. You can line up to four strategies side by side, which is useful when one manager runs a PMS and an AIF version of the same idea.
• Nyra for research. Nyra is described on the site as an AI-powered analytical tool, not a SEBI-registered investment adviser. It reviews portfolios for overlap, drift and fee drag and filters AIFs by category.

What it does not do

• The site has no post-tax return calculator and no fund-level tax data. Listing pages show returns without saying whether they are before or after tax, so that question goes to the manager.
• The Nyra Score does not measure tax. Its methodology lists five pillars: return performance, risk-adjusted return, downside protection, consistency, and structure and stewardship. The page itself says a high-scoring strategy "can be completely wrong for your risk profile, horizon or tax position".

A practical way to combine the two

1. Shortlist on the compare page using strategy, track record and the Nyra Score.
2. For each shortlisted name, note the wrapper: PMS, Category I or II, or Category III.
3. Place it in one of the three strategy rows in this post and write down the likely character of its income.
4. Ask the manager for turnover and the tax rate provided for, then take both to your tax adviser.

That keeps the research and the tax check separate, and makes sure neither is skipped.

• Category III rests on case law. The determinate-trust position comes from court rulings, and the statute still deems shares indeterminate unless stated in the trust deed. The industry body IVCA has said Category III funds are "forced to follow private trust taxation rules" and has flagged the risk of being taxed twice.
• Redemption is not expressly covered. The common position is that Category III investors pay no second tax on redemption. Some professionals warn that no statutory credit mechanism exists. Ask for the fund's written tax position.
• The maximum marginal rate is itself disputed. 39% and 42.744% are both in use.
• Capital gains versus business income is a question of fact for a PMS investor and for a Category III fund. High turnover invites it.
• The fund's surcharge may not match yours. The law taxes a trustee to the same extent as the beneficiary, but funds commonly provide at the highest tier. Investors on lower tiers have no clear refund route.
• PMS rules are about to change. SEBI's Board approved new Portfolio Managers Regulations on 24 September 2026. As of 7 October 2026 we found no notification, so the 2020 Regulations still apply. Nothing in the announcement changes how PMS gains are taxed.
• The illustrations are simplified. They ignore fees, dividends, STT and exit loads, and they assume constant returns.

No structure is the most tax-efficient for everyone. The table below is a general guide.

Three questions settle most cases. What kind of income will the strategy produce? What is your surcharge tier? Do you have losses or gains elsewhere? Take the answers and the product's documents to a tax adviser before investing; your facts will differ from these examples. PMS Sahi Hai and Nyra can help you shortlist strategies and compare them on one basis, but the tax line is something you confirm with the manager and your adviser.

Before you choose between a PMS and an AIF for the same strategy, ask the manager for four things: the portfolio turnover, the share of returns that came from short-term gains or derivatives, the tax rate the fund provides for, and whether reported returns are before or after tax. Then put the two options on the same post-tax basis, using your own surcharge tier and any losses you hold. A tax adviser should confirm the result against the product's documents.

To build the shortlist, compare PMS and AIF strategies side by side on PMS Sahi Hai, ask Nyra to narrow them by category, or book a 15-minute consultation with the team. This article is general information, not tax or investment advice.