Mutual funds are doling out generous commissions to distributors to push their tax-saving equity product to investors, who are scurrying to save taxes towards the end of the current financial year.

The possibility of this product , called equity-linked savings scheme (ELSS), losing its status as a tax saver once a new tax regime comes to effect next year has fund houses going all out to promote it, even at the cost of taking a hit on their financials.

Most mutual funds are paying distributors anywhere between 2.5% and 5.5% of the amount collected for ELSS, according to asset management officials and distributors. ELSS is similar to any diversified equity scheme, but money invested in this product is locked in for three years. Distributors usually get 0.5-1 % for selling other equity schemes.

Mutual funds have paid higher commission for selling ELSS in the past. But this time, its a little higher because of competition, said the marketing head of a bank-sponsored mutual fund, requesting anonymity. The mutual fund tax saver faces the toughest competition from unit-linked insurance plans (ULIPs), which are sold more aggressively by distributors, because of higher commissions.

The extent of commission paid is usually based on the ELSS track record, the mutual funds marketing head said.

ELSS has returned less than 1% on an average in the past three years. Tax savers of Canara Robeco Asset Management, HDFC Mutual Fund, Fidelity Mutual Fund, ICICI Prudential Asset Management and Sahara Mutual Fund have been the best performers, returning 7% to 11% in the past three years.

Distributors said most mutual funds, whose ELSSs are top performers, are paying 2.5-3.5% to distributors. As regulations dont allow mutual funds to pay more than 1% of an investors money as commission to distributors, these firms are paying the balance from their pockets. Mutual funds hope that they would recover the selling costs over the life of product. Industry analysts said such moves are likely to affect the financial position of mutual funds, especially smaller ones.

The transition from a commission-based structure to fee-based will take some time. In the interim, we will see pressure of this kind on mutual funds to garner assets and this may impact their P&L in the short term, said Ashvin Parekh, partner, national leader-global financial services, Ernst & Young.

MFs are in a hurry to lock-in maximum assets under ELSSs before the country moves to the new tax rules, known as the direct tax code scheduled to kick off on April 1, 2012. Investors in unit-linked insurance plans will not get tax benefits, according to proposed tax norms.