Until recently, software professional Ruchir Tiwari was patting his own back for making wise stock market decisions. In October 2008, when the Bombay Stock Exchange Sensitive Index, or Sensex, tumbled to 8,000 levels, he decided to enter the market by buying select blue chips.
Six months back when he booked profits, he had more than doubled his money — from 10 lakh to `25 lakh — in less than two years. And, tax-free as well.
But then, greed took over. A leading brokerage firm's portfolio management services (PMS) arm called Tiwari up and suggested that he seeked a portfolio manager's help. When they told me that a professional fund manager could have earned better returns, I decided to go for PMS.
Seeking higher profits, Tiwari chose to aggressively invest with a portfolio management company.
A month ago, when Tiwari looked at his portfolio, he was happy to see that his money was doing well. Today, my portfolio has grown from `25 lakh to `29 lakh. At the same time, the Sensex has risen from 17,000 to 20,000.
But when he showed the statement to his chartered accountant, he got a shock. He was pointed out that a lot of buying and selling activity in his account led to short-term profit booking. It meant that he would have to shell out a good amount of short-term capital gains at 15 per cent, while filing returns.
High churning of portfolios increases the number of transactions. This, in turn, attracts capital gains tax. Then, the taxman does not consider it as investing, but it becomes trading
PMS is a specialised product, which offers a range of investment strategies by a professional manager who invests in equity, debt and precious metals. The portfolio manager strategises your capital allocation, in line with your financial goals and risk appetite.
Every portfolio management company has a defined, unique style of investing, varying with different schemes. Safer schemes invest in largecap stocks and debt. Some others may invest in midcap and/or smallcap stocks, which pay off in market rallies and are the first ones to fall when the market corrects. Aggressive investors opt for these schemes.
Although portfolio management companies cannot guarantee returns, they churn portfolios that lead to higher tax incidence. And, the churning comes at a cost. Besides, the tax aspect, the income can also get classified as business income.
In the latter case, the entire capital gains get taxed at the highest rate (33 per cent). Tax experts say there is no fixed rule for it and may vary from one person to another, and on the number of transactions or capital gains made. Business income is added to your total salary and taxed according to the applicable tax slab. The taxman may not bother with small gains, but profits of maybe `10 lakh or above in a year can be classified under 'business income' and taxed accordingly.