Mergers of mutual fund schemes are facing the tax roadblock, say market players. In the past couple of years, the Securities and Exchange Board of India (Sebi) has expressed its displeasure to fund houses over the existence of too many similar schemes. However, fund houses say the cost of merging is too high.

Some of the fund houses have progressed on schemes' consolidation but it is not done in a major way. There are certain tax issues around it, such as STT and other tax structures, says H N Sinor, chief executive officer of Association of Mutual Funds in India (Amfi).

Since there is a fresh issue of units in the merged scheme in lieu of units in the merging scheme, the transaction is treated as a transfer under Income Tax Act, 1961. A merger involves the redemption of funds from one or more schemes (which are to be merged) and then purchase in the surviving scheme. As there is selling and buying involved in the transaction, it attracts STT, which can be a significant amount in many cases, says the chief financial officer of a leading fund house.

Currently, the STT in mutual fund schemes' merger is 0.25 per cent of the value or Rs 25,000 on a turnover of Rs 1 crore. This is higher compared with STT of 0.125 per cent or Rs 12,500 on a turnover of Rs 1 crore charged in the delivery-based transaction in the cash market.

Another chief executive officer of a foreign fund house adds, The STT for all such redemptions (during the notice period of 30 days prior to the date of merger from both the schemes) is normally borne by the AMC, as per the current industry practice.

He further explains, During the notice period (exit load-free period), if the investors of the scheme, which is to be merged, are not in agreement with the merger proposal, they have the option to redeem without any exit load being charged from them.

But, if they choose to redeem before the date of merger, the tax implication is similar to any other normal redemption transaction, that is, a capital gains tax of 15 per cent in case the scheme has been held for less than a year, and STT.

While the short-term capital gains tax is borne by the investor, the question is who should pay the STT? Though as of now we are paying it, it should be paid by the AMCs, investors or the schemes, adds the CFO.

Besides the cost factor, there are regulatory approvals that could slow down the process. The process of merging two or more schemes requires a no-objection clearance from Sebi. Following the clearance, the asset management company (AMC) has to make a declaration and allow investors in the source schemes (that are being merged) to exit within a month without any exit load.

The slow pace of the schemes' consolidation can be gauged from the fact that despite Sebis continued nudging, only six players have merged their schemes since January, 2010. Former Sebi Chairman C B Bhave had said last year, If the industry throws over 3,000 schemes at investors, how can one expect them to make a choice? He had also expressed concern over several schemes not even reaching a critical mass.