INDIA BUSINESS WORLD - MAY 2006
THE MONTH THAT WAS...

TAXMEN NOW EXCISE MF UNITS

 The central excise department has indicated that service tax will apply on entry & exit loads. Rattled by the letter, some funds have sought legal advice.

THERE'S no dearth of spoilsports. After CBDT, it's the turn of the central excise department. In a move that has ruffled fund houses in the country, the central excise department has indicated that service tax will be applicable on entry and exit loads linked to mutual fund (MF) schemes.

Loads are charges that investors have to bear while buying or selling mutual fund units. The load is charged over and above the net asset value of the mutual fund scheme. The department recently wrote to mutual funds, making enquiries in this connection. In one such letter, dated May 26, the director general of central excise intelligence said, “...you are requested to indicate whether service tax is being paid by your organisation on the fund management charges indicated as entry or exit load.”

According to mutual funds, these loads are charged to recover part of the scheme expenses on distribution, marketing, advertisement, road shows etc. “However, the central excise department is possibly of the view that loads are a fee against some service,” said a market source.

The department's line of argument could well be that if an investor is willing to pay more than the market price while buying units (due to entry loads) and accept below market price while selling units (due to exit loads), it can only be against a service.

While the central excise department's letter is not a notice from the tax authority in the technical sense, the excise authority has made it amply clear that the government is in favour of levying a service tax on the loads. If it has its way, then the load plus the present 12.24% service tax on the load would together constitute the premium over the market price that investors will have to fork out for each unit.

THE communique has rattled MFs, some of whom have sought legal advice. All the more, since some funds fear the tax could even be imposed for previous years. In such an eventuality, fund house will have to dip into their own pockets to pay the tax. For future schemes, however, it can possibly be recovered from customers.

“However, given the present sentiment, it's unclear whether the government will insist on a service tax on load,” said a source.

The general practice in the fund industry is to pay the brokerage commission from the entry loads. As of today, all fund houses charge entry loads on their equity schemes. SEBI, in its recent had mandated mutual fund houses to meet the expenses related to sales and distribution from the entry load and not through initial issue expenses. Huge amounts — more than Rs 16,000 crore — were collected from various equity based NFOs in '06. Brokerage commissions in some of these schemes went as high as 5%. Industry circles feel the taxation on the entry load would amount to double taxation since distributors brokerage is anyway paid after deducting the service tax. As per latest AUM data, it is Rs 2,57,499 crore. Equity-based assets are roughly over Rs 1 lakh crore or 43% of overall assets.