The Hindu Business Line : Service tax: MFs seek to hike loads

ASSET management companies are lobbying with the Securities and Exchange Board of India to let them charge service tax to investors over and above expenses. If allowed, it would mean higher entry and exit loads on mutual fund schemes.

A top industry source told Business Line that AMCs have been pushing with the regulator to allow them to exclude the eight per cent service tax on brokerage bills from the expense ratio. He, however, did not have much hope of winning SEBI's favour considering that the mutual fund industry was already drawing flak for high expense ratios compared to those in more developed markets such as the UK or the US.

SEBI has capped expense ratio at 2.5 per cent for equity schemes of Rs 300 crore and less. It falls to 2.25 per cent for schemes above Rs 600 crore and to 1.75 per cent for schemes of Rs 1,000 crore or more. Debt schemes' expense ratios are capped 25 basis points lower than that of equity schemes under the respective slabs. In the UK and the US, the expense ratios are typically only a fraction of a percentage point.

"It is a general rule that the larger the fund the lower the expense ratio. However, most mutual funds are already stretched because of high distribution costs," says Mr Sushil K. Sharma, Chief Marketing Officer of ING Vysya Mutual Fund. Mr Sharma admits that Indian MF's expenses do not compare with those in other countries but counters that funds here pay much higher returns than those elsewhere.

Service tax should be excluded when calculating total expense ratio, says Cadogan Financial, a UK-based consultant retained by Asian Development Bank on behalf of the Finance Ministry to suggest reforms to the India mutual fund industry.

The Cadogan study points out: "The levying of service tax on mutual funds is presently regarded by SEBI as an expense which should be included with the total expense ratio limits established by SEBI; any excess of MF expenses over this level has to be borne by the trustees or AMC or sponsors (regulation 52.5). This in effect means that a tax that is mandated by Government to be paid by all entities using certain services may not be borne by that entity, but by one of its service providers - and the level of that tax is not insubstantial. This is irrational since mutual fund investors should be being taxed on a service that they do receive under Indian law."

"Last year when debt funds were paying almost 18 per cent returns, investors did not mind paying 2-2.5 per cent loads. But now when yields have dropped to 5-6 per cent, a fund with the same load looks anything but attractive. The service tax will chase them away altogether," said Mr Sharma.

Currently, brokers pay the tax and AMCs want it to stay that way. Not all distributors are bothered however. The big players make investors pay the service tax or when the client is powerful, get the AMC to pay it. But some of them do get hit. According to the industry source, smaller fund brokers find it hard to recover the tax liability from the investor or the AMC.

While at present SEBI is understood to be unyielding on the industry's demand, tax authorities are increasing pressure on AMCs to sort out the issue.

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