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Taxation Blues

Debt fund investors may have to pay higher expenses because of the Finance Ministry's recent clarification that distributors of mutual funds will have to pay an 8 per cent service tax on the commission they receive for selling funds.

Expenses are set to rise where it matters the most — in debt mutual funds. The reason for this rise is that the Finance Ministry has clarified that distributors of mutual funds will have to pay an eight per cent service tax on the commission they receive for selling funds. In equity funds, most schemes charge close to the maximum permissible. So the imposition of this service tax will not make any difference to investors. AMCs and distributors will have to reduce some of their existing costs to make way for this service tax so that it does not cross the ceiling on expenses.

In the case of debt funds, most AMCs charge much less than the maximum limit. This has largely been done in order to boost returns, at a time when the returns from their portfolio has been shrinking. As returns from debt funds are not very high, a small difference in expenses makes all the difference. So there is scope to charge this service tax to investors by increasing the expense ratio.

Within debt schemes, the impact would be the greatest on liquid funds as their expenses and returns are the lowest. There could also be the issue if this charge is levied uniformly across institutional as well as retail funds. As institutional funds were launched with the purpose of passing on lower expenses to large clients, it is an open question whether funds will increase expenses for their largest and most sensitive clients. Of course AMC could bear this expense, but it would be at the cost of lower profits. Currently, they pay service tax on the asset management charges they receive. As the limit for management charges is also capped by regulation, AMCs would have had to make adjustments in the cases where they were charging the full fee.

Is it logical that service tax be charged in this manner? While the government's logic in identifying commissions as payment for a service rendered is unassailable, commissions are a payment that AMCs make to distributors for services rendered and it seems unfair for this charge to end up with the investors.