GST could make mutual funds more expensive

The compliance with regard to implementation of GST and branch level interstate operations of financial services like mutual funds are expected to be demanding

Budget 2015 brought mutual funds distribution under the ambit of ‘services’, and hence eligible to pay service tax. The service tax rate then was 12.36% and was paid using the reverse charge mechanism. Under this, the onus of paying the service tax was with fund houses, which deducted the tax and paid it to the government. It then gave the net amount to the distributors. Beginning April 2016, the forward charge mechanism has been put in place.

Under this mechanism, the distributors will collect and pay the service tax. The distributor bills the commission amount to the fund house—including the service tax—which the fund house pays her. The distributor then pays the service tax to the government, provided her previous financial year’s income was Rs10 lakh or more.

Also, the distributor gets to subtract from the collected service tax, any service taxes that she may have incurred (and therefore paid) under other business-related expenses such as cable television, electricity and telephone charges. This offset is possible only under the forward charge mechanism, to avoid the cascading effect of paying taxes multiple times.

Beginning April 2016, the service tax was hiked to 15% (including Swachh Bharat and Krishi Kalyan cesses). The new goods and service tax (GST) regime will probably hike this tax to 18%. “I can’t say it is a burden... However, large distributors may be able to bargain for higher commission rates to ensure that their earnings don’t take a hit due to this hike in service tax rate," said Shyam Sunder, managing director, PeakAlpha Investment Services Pvt. Ltd.

Anup Bhaiya, managing director and chief executive officer, Money Honey Financial Services Pvt. Ltd, said that representatives of distributors will have to speak to the finance ministry officials, or respective authorities, to keep the rates in the 12% slab.

Service tax also needs to be paid on management fee and the services rendered by fund houses under the total expense ratio cost head.

As per the Securities and Exchange Board of India (Sebi) rules, fund houses can pass on the service tax charged on management fee to the investors, by increasing the total expense ratio to that extent.

Asset management companies (AMCs) can recover the management fee plus service tax (which the GST replaces) from investors. If there is a higher tax rate, investors will end up paying a higher cost for mutual funds. Another impact on cost can come from the implementation of GST at the state and central levels. GST as per the Model Law is to be paid at the place where a service is deemed to be supplied. Further, as per the model law, the head office and the branch of the AMC would be treated as separate persons. AMCs earn only management fee, which is received at the head office. Many branches of the AMCs carry out operational work but may not be seen as creating any taxable supply.

According to Niren Shethia, executive director, tax and regulatory services, PwC India, “The model law...seeks to suggest that the branch and the head office of an AMC are deemed to be separate persons. If industry forms an interpretation that branches make no taxable supplies then with no offset option at the branches, the overall cost of AMCs could significantly rise.AMCs may look into ways to recover this increase in cost." The chief executive officer of a large AMC said: “There are many vendor requirements at a branch level and this can add to overall costs."

The compliance with regard to implementation of GST and branch level interstate operations of financial services like mutual funds are expected to be demanding. This impacts not just mutual funds but other financial services as well.

Consequently several representations have been made from industry bodies to revise certain parts of the model law to make it simpler to comply with the new tax regime.