Why Small Mutual Fund Agents Are Feeling The GST Squeeze

Small mutual fund distributors face the steepest cut of India’s new unified tax.

The Rs 20-lakh turnover threshold for registering under Goods and Services Tax is irrelevant for them. Both registered and unregistered agents will end up paying 18 percent on their income. The worst hit will be those earning up to Rs 10 lakh as they were earlier exempt from paying service tax at 15 percent.

The Securities and Exchange Board of India has capped fees and does not allow mutual fund agents to pass on the tax as it pushes up the costs for investors. “This threatens the viability of small distributors,” said Dhruv Mehta, chairman, Foundation of Independent Financial Advisors.

Independent advisers and distributors form around half of the mutual fund industry, according to a 2016 PwC report. The agents still contribute almost 90 percent of individual investments despite the regulator’s push for direct selling and extensive investor education campaigns, the report said.

There are about 70,000- 80,000 distributors who earn below Rs 20 lakh a year and will be directly affected, according to Mehta.

GST will squeeze their wafer-thin margins, said Anish Tripathi, director, GST and supply chain advisory services at Lakshmikumaran & Sridharan, Bangalore. Moreover, all mutual fund agents, regardless of their threshold income, will have to get registered if they work in a state different from where a fund is registered, he said.

The problem is two-fold, according to Tripathi.

• Registered distributors are liable to pay GST on their services to the asset management companies for which they can claim input tax credit. As most of them work from small offices with computers as their only equipment, the likelihood of significant input supplies to avail credit is low.
• For unregistered agents, the fund house, which is the receiving the service, will pay 18 percent tax on their behalf and deduct from their commission under the reverse-charge mechanism.

“When GST increased the limit to an annual income of Rs 20 lakh, I was very happy,” said Samir Deshpandey, a distributor from Powai, Mumbai who said he earns below Rs 10 lakh. “Then I saw the fine print and realised that even if I don’t register, I will have to pay 18 percent.”

While Deshpandey and others like him can’t claim tax credit, fund houses can. “We are allowed to claim input tax credit on the 18 percent GST we pay as reverse charge for an unregistered mutual fund distributor but we cannot pass it on to him,” said Aashish P Somaiyaa, CEO, Motilal Oswal AMC⁠⁠⁠⁠.

Expense Ratio

SEBI capped distributors’ fees to check mis-selling of schemes just to earn commissions. Rules allow maximum costs of 2.5 percent to be passed on to customers of an equity mutual fund scheme and 2.25 percent for a debt fund scheme. As the size of the scheme increases, the expense ratio, or the portion of the total assets that can be set aside for administrative expenses, falls as the fixed costs remain the same.

The average expense ratio is 2.09 percent for equity funds, 1 percent for debt funds and 0.3-0.4 percent for money market instruments, according to a study by distributors’ body. The average commission received by distributors for all schemes this year stood at 0.6 percent, which highlights the thin margins in the industry.

If GST on the commission is passed on, the cost for an investor will go up by a fifth of a percentage point, which is not big as they usually earn returns of 11-12 percent, said Mehta.

The independent financial advisers’ body wrote to Revenue Secretary Hasmukh Adhia saying that in all other banking and financial services, companies are allowed to pass on the burden of any tax paid by agents. They demanded parity.