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MF investors may face service tax whammy
December, 27th 2011

Investors may end up shouldering higher costs for their equity mutual fund investments if the recommendation of a Securities and Exchange Board of India (Sebi)-appointed panel on mutual fund is approved by the regulator. The committee has suggested exclusion of service tax from the fee that investors pay mutual funds every year, measured as expense ratio.

The move would bring down the expense ratio to 2.4% from the current 2.5% on equity schemes with assets below 100 crore, but the excluded service tax could effectively increase the overall charges of investors to 2.6% (where funds get 1.25% of management fees), industry officials said.

The panel has recommended that the 10.03% service tax could be levied on investors over and above the 2.4% expense ratio. In the case of debt funds, the committee has slashed expense ratio from 2.25% to a maximum of 2.15%, excluding service tax.

"This is a kind of an eye-wash if seen from an investors' point of view. Investors will end up paying more if they exclude service tax from expense ratio bracket," said the national head (financial services) of a leading audit firm.

"But then, fund houses are right in taking such a step as they do not have much leeway to earn profits under the current expense structure. Even if Sebi agrees to this formula, mutual fund will still be cheaper than insurance products in terms of expense charges," he said.

The Sebi-appointed committee has capped the expense charged on exchange-traded funds and fund-of-funds at 1% after keeping out the service tax. Expense ratio is the fee charged by a fund house to manage and operate the fund. The charges include management fees, administrative fees, and other operating costs.

The panel has sought opinion from all fund houses before submitting the final draft to Sebi. Reversing an earlier proposal, the committee has decided to keep the expense ratio slabs unchanged. The first 100 crore will attract a maximum expense ratio of 2.4% (which excluds the service tax). Schemes with larger asset bases will have to trace the slab and mandatorily bring down their expense ratio. Funds having 800 crore and above will be allowed to charge a maximum of 1.75% as expense ratio.

The Sebi panel has also proposed to keep exit load on equity mutual funds at 1%. The catch, however, is that fund houses will not get the entire 1%, if an investor redeems his money from the scheme before one year.

"A formula will be drawn wherein fund houses will get only 30-40% of the exit load. The remaining money will be reinvested into the fund. This is done to reward investors who are staying invested in the fund. The formula will be drawn taking into consideration problems faced by fund houses in times of early redemptions by investors," said a member of this committee.

The panel has recommended to the regulator's board to break down the bifurcation within the expense ratio. This step will allow mutual funds to manage their expenses better and could improve their profits.

"This move will help larger fund houses more than anybody else," said the chief executive of mid-sized fund house.

"Fund houses with large schemes have the leeway to reduce expense ratio below 1.4%. But they are not doing that; they still charge 1.8-1.9% as total expense ratio. With the exclusion of service tax and bifurcations within expense ratio, these fund houses will have enough money to pay distributors and push their schemes," the chief executive said.

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