Taxation of Dividend Pass-Through in PMS for HNI Investors

For high-net-worth individuals (HNIs) in India, dividend income can be a meaningful part of long-term equity returns. Under a Portfolio Management Services (PMS) structure, dividend taxation can create more friction than in Mutual Fund growth schemes.

Following the abolition of the Dividend Distribution Tax (DDT) in the 2020 Union Budget, dividends became taxable in the hands of investors.

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1. The Abolition of DDT and the Shift to Individual Slab Rates

Prior to 2020, Indian companies paid a Dividend Distribution Tax (DDT) before distributing dividends. The dividend received by the investor was tax-free (up to ₹10 Lakhs, after which a 10% tax applied).

The New Rule (Post-2020)

The 2020 Finance Act abolished DDT entirely.

• Company Level: Companies now distribute 100% of their dividends without paying DDT at the corporate level.
• Investor Level: Dividends are now treated as income and are fully taxable in the hands of the investor at their individual income tax slab rate. For individuals, surcharge on dividend tax is capped at 15%; after 4% cess, the highest effective rate on such dividend income is generally 35.88%, subject to marginal relief.

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2. The Tax Friction: PMS vs. Mutual Funds

Because of the differences in asset structures, this tax change can disadvantage PMS portfolios compared with Mutual Fund growth options.

PMS Dividend Friction (Slab Rate Drag)

• Asset Structure: You own the shares directly in your custom Demat account.
• Dividend Flow: Dividends are credited directly to your bank account.
• Tax Event: The dividend is immediately taxable as "Income from Other Sources" at your individual slab rate.
• Friction: An investor in the highest bracket can owe an effective rate of up to about 35.88% on dividend income, subject to marginal relief, before the balance can be re-invested.

Mutual Fund Dividend Advantage (Tax-Free Compound)

• Asset Structure: You own units of a trust. The trust owns the shares.
• Dividend Flow: Dividends are paid to the mutual fund trust pool, which is legally exempt from income tax under Section 10(23D).
• Tax Event: Zero immediate tax. The dividend is accumulated and re-invested tax-free inside the Growth scheme.
• Advantage: You only pay capital gains tax (12.5% LTCG) when you eventually redeem your mutual fund units years later, allowing 100% of the dividend to compound tax-free in the interim.

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3. Tax Deducted at Source (TDS) on Dividends

To ensure compliance, listed Indian companies are legally required to deduct Tax Deducted at Source (TDS) on dividend payments.

• TDS Rate: 10% on dividend payments exceeding ₹10,000 per financial year per company.
• NRI Investors: For non-resident Indian (NRI) PMS investors, the TDS rate on dividends is 20% (plus applicable surcharge and cess) or the rate specified under the Double Taxation Avoidance Agreement (DTAA), whichever is lower, causing immediate cash-flow friction.

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4. How Dividends Are Taxed Under the Income-tax Act, 2025

From 1 April 2026, dividend income is governed by the Income-tax Act, 2025. The mechanics for a resident PMS investor are:

• Head of income. Dividends are chargeable under "Income from other sources" (section 92(2)(a)).
• Rate. They are added to your total income and taxed at your slab rate. Under the default new regime (section 202), the top 30% rate applies to total income above ₹24 lakh.
• No deductions. The Finance Act, 2026 amended section 93 so that no deduction is allowed in respect of dividend income. PMS fees, interest on borrowed money and collection charges cannot be set against your dividends.
• TDS by the company. A domestic company deducts tax at 10% on dividends (section 393(1), Table Sl. No. 7). For an individual shareholder, no TDS is required where the dividend is paid other than in cash and the total paid by that company in the tax year does not exceed ₹10,000. TDS is only an advance payment: the final tax is computed at your slab rate when you file.
• Non-residents. The Finance Act, 2026 rates for deduction of tax at source specify 20% on dividend income of non-resident individuals (other than specific categories), subject to any lower treaty rate you are entitled to claim.

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5. A Worked Example: What Dividend Drag Costs

The numbers below are assumptions for illustration, not a forecast.

• PMS portfolio: ₹1 crore.
• Assumed dividend yield of the underlying stocks: 1.5% a year, so ₹1.5 lakh of dividends.
• Investor in the 30% slab under the new regime, with total income below the surcharge threshold.
• Tax: 30% + 4% cess = 31.2%, or about ₹46,800 a year, paid in the year the dividend is received.

Now compare an equity mutual fund in the Growth option holding similar stocks. The fund receives the same dividends, but a SEBI-registered mutual fund is exempt from income tax (Schedule VII, Table Sl. No. 20), so the full ₹1.5 lakh stays invested. You pay tax only when you redeem: 12.5% on long-term gains above the annual ₹1.25 lakh exemption (section 198), or 20% on short-term gains (section 196), plus surcharge and cess where applicable. The difference is deferral plus a lower rate on the eventual gain, compounded over every year you stay invested.

The drag grows with three things: a higher dividend yield (PSU, utility and "dividend" strategies), a higher slab, and a longer holding period. It is close to irrelevant for a low-yield growth portfolio held by someone with modest other income.

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6. IDCW Is Not the Fix

Some investors try to dodge the PMS dividend issue by choosing a mutual fund's IDCW (dividend) option instead. That recreates the same problem. IDCW payouts from a mutual fund are taxable in your hands at slab rate, and the fund deducts TDS at 10% where the income in respect of units exceeds ₹10,000 in the year (section 393(1), Table Sl. No. 4(i)). If you want regular cash from a mutual fund, a Growth option with a planned withdrawal usually keeps more of the money working; our PMS vs mutual funds guide covers the wider comparison.

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7. What to Check in Your PMS Statements

• Gross vs net. Your quarterly PMS report must show beneficial interest received during the period, including dividends. Reconcile the gross dividend there with the TDS credits in your annual tax statement.
• Strategy yield. Ask the manager for the portfolio's trailing dividend yield. A high-yield strategy is a tax decision as much as an investment one.
• Cash drag. Dividends land as cash. Ask how quickly the manager redeploys it and whether idle cash is parked in liquid funds.
• Regime choice. Dividend tax depends on your total income and regime. Model it with your CA alongside your capital gains for the year, not in isolation.

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Section numbers under the Income-tax Act, 2025

The Income-tax Act, 2025 replaced the Income-tax Act, 1961 from 1 April 2026, so from tax year 2026-27 these rules sit under new section numbers. This guide uses the familiar 1961 numbers; the table maps each one it cites to the corresponding provision of the 2025 Act.

Income-tax Act, 1961	Income-tax Act, 2025	What it covers
Section 10(23D)	Schedule VII, Table Sl. No. 20 (via section 11)	SEBI-registered mutual funds are exempt from tax

FAQ

Does the PMS manager re-invest my dividends?

Yes. The dividends are typically credited to your linked bank account, and the PMS manager's system tracks the credit and re-invests the cash into the portfolio on your behalf. However, the manager does not pay the tax for you—you are fully liable for the tax on the gross dividend credited.

Can PMS management fees be offset against dividend income?

No. Under the current Income Tax Act, you cannot deduct PMS management fees, transaction costs, or advisory charges from your dividend income. The dividend is taxed on a gross basis as "Income from Other Sources."

Is there a tax difference between Growth and Dividend options in PMS?

Unlike Mutual Funds, a PMS does not have "Growth" or "IDCW (Dividend)" options. Because you own the underlying shares directly, any dividend declared by a portfolio company is legally your income and will be distributed and taxed immediately.

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Sources

• Income Tax Department — Capital gains
• SEBI — Guidelines for Portfolio Managers (February 2020)
• Association of Portfolio Managers in India (APMI) — PMS performance disclosures
• Income-tax Act, 2025 (Gazette of India, 21 August 2025) — sections 92, 93, 196, 198, 202, 393 and Schedule VII
• Finance Act, 2026 (Gazette of India, 30 March 2026) — amendment of section 93 and rates for deduction of tax at source
• SEBI — FAQs on Portfolio Managers (20 September 2024), quarterly client reports
• PIB — Income-tax Act, 2025 comes into force on 1 April 2026