Ban on MF loads may lead to tax leaks, cartels

ToI 29/6/09

Mumbai: Sebi’s decision to abolish entry loads in mutual fund (MF) schemes can have at least three unintended outcomes. While there could be huge slippages of service tax paid by the fund industry, it could also lead to proliferation of bogus independent financial advisors (IFAs) and misselling of MF schemes, industry officials said. They also believe that in the long run, the decision could lead to cartelisation in the MF industry with just a handful of large funds houses and distributors ruling the market.

Currently, when an investor opts for a scheme, the fund house directly deducts service tax from the commission it pays to the distributor or IFA. In turn, the fund house deposits this with the government. But very soon, fund houses will not have anything to do with the service tax over distribution commission, since under the new structure, investors will pay the commission directly to the distributor/IFA. So the onus of paying service tax will now be on the distributor/IFA.

Industry officials say that under the changed system, the onus will be on the advisor to pay the service tax on advisory commission. “Chances are there will be substantial leakage of revenue for government through under-reporting or non-reporting of advisory commission,’’ said a top fund industry official at an AMC.

Industry estimates that in the last financial year total service tax paid by the fund houses was about Rs 160 crore. The year before, when markets were doing better, it was much higher, at over Rs 250 crore. “A large chunk of this could remain with advisors now. And if we take a modest 20% annual growth of the MF industry, the cumulative loss to the exchequer could be substantial,’’ the official pointed out.

Another fallout of the changed fee structure could be proliferation of advisors without proper training and registration in the fund industry. “At present we (AMCs) pay commission only to the AMFI registered distributors and IFAs. After the change, anyone can become an advisor and charge the investor for advice,’’ a fund official said. “There is high chance that some bogus advisors will join the industry who will not serve the cause of common investors.’’

Another fallout could be squeezing out of AMCs and distributors with limited financial resources and growth of larger players. In the changed scenario of no entry load, AMCs will have lesser funds at their disposal for marketing and business expansion. Likewise only distributors with deep pockets can spend money to expand their business.

“In such a situation AMCs and distributors with deep pockets will survive while the smaller ones will exit the business,’’ a top official at a financial services company said. “The incentive to serve small investors is just gone,’’ a fund manager said.

The fund industry suggests a way to get out of this situation: Increase annual expense fees that AMCs charge on investors, which at present, is graded. For managing assets of up to Rs 100 crore, AMCs can charge up to 2.5% of the assets. This comes down to 2.25% for the next Rs 300 crore of AUM and 2% for the next Rs 300 crore. And for AUM of over Rs 700 crore, a flat 1.75% of the assets is charged annually. “Make this expense ratio uniform at 2.5% and we will take care of all the costs,’’ said a director at a large AMC.

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3 thoughts on “Ban on MF loads may lead to tax leaks, cartels

  1. Vivek has raised a very important point that in the new scenario, there could be some Non-AMFI cleared advisors who would charge fees from some investors on some pretext or the other. Has SEBI looked into this?

    Talking about the stupidity of the idea, just imagine you going to a Hero Honda motorcycle showroom (dealer) and you giving them two cheques: one to the Company directly and the other to the Dealer after asking how much profit is made by him. Scale that down to everyday stuff like soaps, shampoo, cream etc and one would understand that this scheme is NOT going to work at all. And why just target MF advisors? Why Not all such dealers and distributors of all financial (read insurance) and non finacial products such as cars, soaps, petrol and match sticks!

    Pranabda, are you listening?

    ARN 21203

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  2. SEBI seem to be concerned that investors who do not have adequate investment knowledge are taken for a ride by unscrupulous advisors. The root to the problem is at the AMCs. In order to garner AUM they have been floating new funds (soon some fund houses fact sheet may be as thick as a telephone directory)and also incorrctly promoting dividend declaration as a sales tool.
    SEBi should prevent:

    AMCs from floating NFOs which overlap even partly with any one existing scheme
    Allow only innovative schemes as NFOs (templeton dynamic PE ratio fund)
    Forbid AMCs from announcing Dividend declaration widely. This must be a mute affair and should not mislead investors to invest.

    Forbid AMCs from announcing attractive incentives – trips abroad, additional incentives, per application incentive etc.

    This will take care a good part of mis selling.

    SEBI and AMFI shoyld spend their energy in educating investors vigorously on the basic tenets of investing – let them understand NAV should not be a guiding factor to investing, dividend declaration should not be a motivating factor to invest.

    They must also be educated on understanding the interpretetation of fact sheet info and also usefulness of investing in debt schemes like FMP at appropriate time.

    This will ensure low or nil churning and survival of the fittest and quality advice to ivnestors.

    I wonder if any member of SEBI will pay their advisors seperately by cheque taking down the pan no. of the advisor and deducting tax at source and deposit at the appropriate place.

    And none of these persons will bat an eyelid when an insurance scheme fleeces them.

    Do we know how much profit HLL makes on Lifebuoyor coccola maks on sprite or Lays on the chips packet. If this be the case why any one who buys a financial product should now his cost?

    SEBI should attack the problem at the right place. They have taken the easy way out and have chosen soft targets.

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  3. Vivek has very clearly stated the facts. This apart the government exchequer will also loose out the Income Tax that will be payable by these Advisors. SEBI talks about spreading the investment cult among the small investors in a big way but in practice they are killing the people who can do it. SEBI should concentrate on macro issues and allow the market to decide micro issues like these.

    Regards
    Srini

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