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Investors face service tax hit in mutual fund-distributor standoff
April, 16th 2015

Returns from mutual fund schemes will dip if investors find themselves at the wrong end of the raging feud between mutual funds and the distributors. An influential mutual fund distributor body — consisting of Citibank, Standard Chartered Bank, Aditya Birla Money, Bajaj Capital and NJ India Invest among others — has told the Association of Mutual Funds of India (Amfi) that these intermediaries would not bear the burden of service tax introduced in the Union Budget.

Financial Intermediaries Association of India (FIAI) has asked the asset management companies to bear the burden or pass it on to the investors. There are about 60,000 mutual fund distributors in the country, of which over 40,000 are IFAI members. If mutual funds include the service tax in the expense ratio —the amount that mutual funds charge investors — it will increase the cost of investing in their schemes.

From April 1, mutual fund distributors have to pay service tax of 14%. Soon after this was announced in the Budget, distribunettors had approached mutual funds to add the tax to the expense ratio. But, Amfi, the mutual fund industry body, said distributors have to pay it. The distributor body FIAI, in a letter to AMFI dated April 10, has argued that the service tax has to be borne by the recipient of the services.

"In no case, an additional burden of 14% is viable for any member of the distribution community to run their business as most are operating at less than 14% net profit margin," it said in a letter. FIAI, which has sought legal opinion from law firm Nishith Desai Associates, has threatened legal action against Amfi if it did not respond in 'reasonable time'.

The fresh conflict between mutual funds and distributors comes on the heels of a recent Amfi move asking mutual funds to limit the upfront commission they pay distributors at 1%. The upfront fee cap has hurt distributors, mainly the smaller ones. A source familiar with the matter said distributors are arguing that mutual funds are charging investors service tax over and above the expense ratio.

"If mutual funds are passing on the burden to unit-holders, why should distributors pay service tax," said the person in the know. At present, rules allow mutual funds to have an expense ratio of 2.5%, out of which 1.5% is the asset management fee. Till recently, a service tax of 12% was applicable on the asset management fee, which was charged to the client, pushing up the total cost to 2.68%. If the service tax levy is passed on to the investor, the total cost of investing in a scheme would be 2.86%, which includes 14% service tax. This would end up being higher if the scheme is bought by investors outside the top 15 cities.

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