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Recent direction to force MF distributors to pay service tax ill-advised
May, 12th 2015

There's pressure on MFs to cut down on expenses that mutual funds charge their investors. However, the recent direction taken by the fund industry may be counter-productive and be harmful for the development of fund investing in India. A few days ago, an internal communication of the industry's lobbying body, the Association of Mutual Funds of India (AMFI) asked its members to force fund distributors to pay service tax themselves instead of being able to pass it on to consumers. Here's what it told its members, "On the question of Service Tax on distribution of mutual fund products, it was clarified that the Service Tax will have to be borne by the distributors for the services provided."

This is a bad idea, and not just for one reason. Firstly, fund expenses in India have been edging higher and should be brought down. I've written about this issue in this newspaper earlier. To recap, this is what the situation has been so far. Over the last 3 years, the number of regulatory changes has brought the cost to equity fund investors to 3% per annum of the value of their investments.

Till 2012, this number was capped at a level ranging from 1.75-2.5%. Within this, there was a limit of up to 1.25% for management fees and the rest was for actual expenses.

If actual expenses were lower, then funds stayed under their limit. However, acceding to demands from the fund industry, Sebi clubbed the two in a single limit. Since then, every fund hits the ceiling that is available to it.

However, the actual expenses that investors are charged are even higher. One reason was a sharp hike in the service tax.

Earlier, this was charged only on management fee and that too had to come from within the overall limit. However, with the expenses in a single pool, service tax became chargeable on the entire amount, and Sebi permitted it to be charged over and above the limit. From this financial year, commission paid to distributors has also been brought into the service tax net. Now, faced with increasing criticism about high expenses, comes this latest move that I have described above. It so happens that in every category of service, the customer pays service tax additionally to what the seller charges. This principle is universally followed, including in other financial services like insurance. However, what the funds are trying to do is something unfair. AMFI is attempting to limit expenses by forcing distributors to pay service tax out of their own pockets while its own members (the funds themselves) will continue to pass on service tax to investors.

How this ridiculous discrimination against distributors strikes anyone as a legitimate way of reducing expenses charged to investors is a puzzle.

Moreover, having observed the way the industry has worked, my suspicion is that big powerful distributors like banks will still manage to extract whatever they lose on the service tax front and the axe will actually fall on smaller independent financial advisors (IFAs). That's a pity because many of these IFAs have played a great role in expanding the reach of MFs.

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