An extract from the Finance Bill that deals with service tax on MF commissions is reproduced below:
Exemptions are being withdrawn on the following services:
(a) services provided by a mutual fund agent to a mutual fund or assets management company;
(b) distributor to a mutual fund or AMC; and
(c) selling or marketing agent of lottery ticket to a distributor of lottery.
Services provided by mutual fund agents, mutual fund distributors and lottery agents are being brought to under reverse charge consequent to withdrawal of exemption on such services.
There have been intense discussions and debates in the industry over the last few days to understand who finally is going to pay the service tax. WF Discussion Forum has also seen many discussions around this and related issues over the last week. Some industry associations like FIFA and DFDA have done a lot of homework on this issue, FIFA has held detailed discussions with fund houses. IFAs are worried whether this means that their income will shrink by 14% from April, and have been very vocal about how unfair the situation will be if their commission income is subject simultaneously to service tax and income tax.
Who bears the service tax burden - the consumer or the provider of the service?
There are several ways to look at this issue, but perhaps one simple way that can hopefully point us to a solution. Service tax is an indirect tax, while income tax is a direct tax. Income tax - like other direct taxes - is levied directly on the individual who the Government seeks to collect it from. Indirect taxes - like sales tax, excise duty, service tax - are taxes that are levied at the point of manufacture or sale of goods or rendering of a service, and are intended to be borne by the consumer of the goods and the service. The provider of goods and services is made responsible to collect the tax from the consumer and pay it to the Government. It is not the expectation of the Government that an indirect tax will be borne by the producer of goods or the deliverer of a service - else, it would be a direct tax. If we accept this basic premise, the focus then shifts to who is the consumer of the distributor's service.
Who is the consumer of a distributor's service?
The extract from the Finance Bill reproduced above clearly articulates that a mutual fund distributor is rendering a service to the mutual fund or the AMC. The service provider is the distributor, the receiver of the service is either the fund (the schemes) or the AMC. In fact, it is AMCs who sign distribution agreements with ARN holders, to sell schemes of their mutual fund. One can argue that the entity receiving the services of a distributor is the AMC.
The AMC in turn offers its services to the mutual fund, for which it raises a bill for management fees on the schemes, on which a service tax is levied, which is charged to the scheme and therefore borne by the end consumer - the investors, by way of total expenses debited to the scheme. Service tax on management fees is charged over and above the TER cap prescribed under SEBI guidelines - which means that the service tax on management fees is clearly borne by investors.
What about other service providers - like R&T agents?
There are other service providers too in the picture - notably R&T agents. From what I understand, the services they render are also charged to the scheme and service tax is levied on their charges too. The difference here is that this service tax, though charged to the scheme, is not over and above the TER cap - which means it needs to be accommodated within existing expense ratio ceilings. The R&T agent is however not expected to bear the service tax incidence - it is charged to the scheme and therefore borne by the end consumer by way of inclusion in the expenses that investors will pay, which are subject to an overall TER cap.
Who therefore will bear the cost of service tax on distribution commissions?
In light of this scenario, service tax levied on the service provided by a distributor to the AMC and/or the mutual fund is to be borne by the consumer. If the AMC is the consumer of this service, it in turn provides a service to the schemes by way of managing them, and there is a service tax incidence on the fees it charges the schemes. There can be a set off available between the service tax that the AMC recovers from the scheme and the service tax that it is supposed to bear on distribution services availed. The net amount is what the AMC is supposed to pay to the Government.
The difficulty here is that many fund houses charge trail commissions directly to the schemes concerned and charge upfronts either to the AMC or partly to AMC and partly to the scheme, based on the capacity of each scheme's TER to bear these expenses within the cap. When commissions are debited directly to the scheme, a set off is not available, and therefore there is a question of who is going to pick up the tab. If service tax on commissions is debited to the scheme, that automatically means the AMC's ability to charge its fees and expenses diminishes, because the cap is the same. This will imply that the AMC effectively bears the service tax impact, in an indirect way.
An alternative solution, in the current era of fungibility of expenses, is for the AMC to charge all distribution commissions to the AMC and not the scheme. It can then charge a higher management fee to the scheme, on which service tax is levied, but then this service tax on management fee is over and above the TER cap. This means that it will be the investor who will finally pay for service tax on distribution commissions, as the effective expense ratio will go up.
The point to consider, in my view is this: who is the final consumer of a distributor's service? Is it the AMC or the investor? It is the final consumer of a service who is supposed to bear the tax on the service rendered.
From what I understand, the thinking among some of the leading fund houses is that the AMC should charge commissions to the AMC and not the schemes, should hike the management fee debited to the scheme accordingly, and apply service tax on the enhanced fees to the scheme - which means investors will finally pay this tax. This view will however need to be vetted by tax experts, and I understand AMFI has been asked by its Board to seek a formal opinion on this matter, before a decision is finally taken.
We will need to await the final word on this matter, and for AMFI to receive the necessary opinions from tax experts. It is encouraging to note that fund houses are exploring options to make distributors effectively "service tax neutral". It appears, subject to tax experts corroborating our view, that it will finally be the investor who bears the service tax burden on distribution commissions. There can be a cogent argument put forward that the investor is being served by a distributor and should therefore bear the service tax burden - just as he bears with insurance products he buys and banking services he avails. That this will further increase expense ratios which are already quite high, is of course an entirely different matter, and a valid concern too.
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