I have written on the service tax issue almost a month ago (Who's going to finally pay the service tax?) where I argued that it seems against the principles of natural justice that a service provider be asked to bear the incidence of service tax on the services he renders. In all other services in the country, it is the consumer who bears the incidence of this tax. In this case, the debate is whether the consumer is the AMC or the investor. One can argue that since the fund industry has direct and regular plans, an investor who chooses the regular plan, is making a conscious choice to avail a distributor's service. In this case, the investor must bear the service tax incidence. The way an investor bears this is through a debit to the scheme's expenses.
SEBI, we are told, has not allowed scheme expenses to be increased beyond the current caps to accommodate service tax on distribution commission. Lets look at each product category to see where really the issue lies from SEBI's stated stance.
Debt and liquid schemes - don't see a problem here
Scheme expenses for liquid and debt schemes are anyway significantly below the TER caps. So there should really be no issue in debiting commissions and service tax to the schemes for these asset classes. If a debt fund's TER is currently at 150 bps, the AMC may have to raise it to 160 bps in order to allow room for debiting service tax on commissions to the scheme. The investor will therefore pay the service tax, by way of higher expenses. SEBI does not really come into the picture here since the TER is well below the regulatory cap. This then is purely a commercial call that individual AMCs have to take. Do they think the product category can be sold with an expense ratio of 160 bps instead of 150 bps? If yes, then it is a simple matter. If no, then a commercial call needs to be taken by AMCs and their distributors about who takes how much of a haircut to accommodate service tax on commissions within the existing market determined TER. I suppose in the current declining interest rate environment, a fair conclusion can be reached that the market can bear an additional 10 bps of cost on the product. Once interest rates settle down at a lower level, return expectations will come down, and along with that, TERs will come down as will commissions. But that is normal market forces that will play out. For the moment, I for one will be surprised if AMCs decide that TERs on debt funds cannot be increased to offset service tax on commissions.
Upfront commissions on equity funds - could go either way
Equity funds usually operate at the maximum permissible TER. Commissions on equity funds are typically at two levels - upfront and trail. Upfront commissions are usually debited to the AMC while trail commissions are usually debited to the scheme. Service tax on upfront commission can potentially be set off against service tax that the AMC collects from the scheme on management fees it charges to the scheme. If an AMC charges a 1% management fee on the total corpus of the scheme, the upfront commission of 1% on new sales within the scheme will surely be less than the management fee charged. It therefore follows that service tax on upfront commissions can be set off against service tax on management fees. If a set off is possible, there is really nobody who is bearing the incidence of service tax on upfront commissions - in reality the set off means a loss to the exchequer.
Before we jump to the conclusion that there is therefore no problem with service tax on upfront commissions on equity funds, we need to bear in mind that there can be a twist in the tale. AMFI's committee that is examining the service tax issue is not entirely certain that a set off will be allowed by the Service Tax Department. This is a bit technical - but the sum and substance is that there is an even chance that the revenue authorities may disallow the set-off - and this disallowance typically happens in an audit that comes up only once in 3 years. AMCs will therefore have to take expert legal opinion that they believe clearly allows them a set off, before they can commit to such a course of action. Perhaps we may find different AMCs taking different stances on this one, in the weeks ahead.
Trail commissions on equity funds - someone's going to take a haircut here
Then there is a final piece - service tax on trail commission debited to the scheme. I have already argued in my previous article, that there are several other service providers whose expenses are similarly debited to the scheme - including the R&T agent, the custodian, the trustees, the auditors and so on. In all these cases, service tax is debited to the scheme (which means the investor bears the incidence of this tax). These service tax debits are not grossed up in the TER - only service tax on an AMC's management fee is grossed up over and above the TER cap.
In reality, for equity funds, all these service tax debits on services rendered by R&T agents, custodians, trustees etc. mean that the AMC's ability to charge marketing expenses to the scheme gets reduced proportionately, since TER is capped. In an indirect way therefore, the entity that really bears the incidence of service tax from services of R&T agents, custodians, trustees and auditors is the AMC.
When it comes to service tax on trail commissions for equity funds, we are talking about much larger amounts and therefore much larger service tax incidence. If the weighted average trail commission is 1%, that's 14 bps of a service tax cost that someone has to bear. AMCs are reluctant to absorb this, SEBI is unwilling to gross up the TER cap. The question therefore is who is going to bear the incidence of service tax on trail commissions on equity funds.
So who will finally pay - distributor or AMC?
From what I understand, most distribution agreements specify that the commission rates communicated by AMCs are all inclusive (inclusive of all rates and taxes). The starting point for AMCs therefore is likely to be that for equity funds, the agreements provide them an ability to ask the distributor to bear the service tax incidence, since the commission is all inclusive.
The reality however is that commission rates for this quarter are being finalized as we pen this article. AMCs who would like to minimize service tax burden on distributors will be more willing to gross up the commissions for this quarter, to make distributors as service tax neutral as possible on equity funds. Some may decide that both stakeholders take a haircut - AMC and distributor. Others may decide that they really have no capacity to bear this burden and may ask distributors to bear it in full. This therefore boils down to market forces and negotiations between AMCs and distributors. One impediment in this of course is the new commission caps that come into force today. All negotiations will be subject to an overriding cap on commissions, as prescribed by AMFI's best practice guidelines, for those AMCs who choose to adopt the guidelines in toto.
So has your income come down by 14% from today because of service tax? Unlikely. As mentioned, I don't see an issue with debt and liquid funds. As regards equity funds, if set off is indeed available for upfront commissions charged to the AMC books, no problems there as well. The haircuts therefore are largely with respect to service tax on trail commission on equity funds and potentially upfronts too on equity funds. In the coming weeks, as AMCs roll out their commission structures for the quarter, you will get a clearer picture of just how much of a dent service tax is going to make in your income for the year ahead.
Share this article
|
