GST On Exit Loads Of Mutual Fund Schemes—Is It A Regressive Step?   Jun 11, 2018

Exit Load

The Narendra Modi government implemented the Goods and Services Tax (GST) on July 01, 2017. It was considered as one of the most revolutionary indirect tax reforms in the history of independent India.

One year on, it continues to receive a mixed response. Some reports, including one published by the World Bank, highlight the complexities involved in the operation of the GST.

Many experts are now of the opinion that the rates must be lowered and the law must be simplified further. This is because the cost of compliance is creating working capital problems for the companies.

Nevertheless, the government seems to be barking up the wrong tree again.

As far as financial services are concerned, an instance of 18% tax has made them expensive. If that wasn’t enough, the government is now trying to expand the scope of “financial services” beyond its logical meaning.

It recently clarified that the exit loads charged by mutual funds will attract GST now.

Earlier, the industry body, AMFI (Association of Mutual Funds in India), had made representations to the finance ministry to not impose GST on exit loads.

But that seems to have fallen on deaf ears. In the Frequently Asked Questions (FAQs) on GST, the government has clarified that the exit loads will be subject to GST now.

Exit load in the form of a fee (whether or not as a fixed percentage of the investment) is liable to GST. Even if the exit load is in the form of units in the fund, it may be concluded that the consideration received in money was later converted to NAV units.

Let’s first see what exactly the exit load is…

The exit load is the fee charged to investors on the premature redemption of their investments.

Now, you might wonder how the ‘premature exits’ are defined.  

The simple answer is the scheme category decides whether or not the timing of your exit is premature.

For example, a short-term debt fund might impose a penalty of 0.5%, in case you exit before the completion of 3 months. But on the other hand, an equity-oriented mutual fund scheme might charge 1% exit load for all redemptions within the first 12 months of investments.

Is it a hidden charge?

Of course not! In fact, all mutual fund schemes communicate about exit loads actively.

Where can you find information about them?

You may find information on exit loads on the website of a mutual fund or in any of its product communiqués. PersonalFN can also be a handy source if you want to find out the exit load of each scheme you have invested in. PersonalFN’s Scheme Finder will help you get information on exit loads of various schemes.

Why is the exit load charged?

Mainly for two reasons.

First, to acquire a customer, mutual fund houses incur some costs, which may vary from one fund house to another depending on multiple factors such as marketing budgets, geographical reach, etc.

After the entry loads got banned, the cost of client acquisition significantly went up for several mutual fund houses. An entry load was nothing but an upfront fee charged to investors every time they invested in mutual funds. 

In the absence of entry loads, mutual fund houses started imposing exit loads as a standard practice. This is because, unless you stay invested for a stipulated time period, they don’t make much of profit.

Second, exit load is charged to discourage unwarranted outflows from mutual fund schemes which make the job of a fund manager tougher.

Is it logical to charge GST on the exit load?

The plain answer is, No!

The exit load doesn't improve the earnings of a mutual fund in any way. Money collected by way of exit load is ploughed back into the scheme, so that those exiting prematurely don't affect the prospects of the investors who prefer to remain invested.

Thus, imposing GST at 18% (which is likely to be the rate) may work to the disadvantage of the investors who prefer to stay invested.

But the government might have its own justification.

While the government is yet to offer clarity on how this will be implemented, it appears that the exit load will be inclusive of GST. Investors will not have to pay a separate tax amount.

If this happens, there are two possibilities

  • The existing exit load structure of mutual fund schemes will be revised upwards. This means those charging 1% exit load might start charging 1.18% exit loads.

  • And if the load structure isn’t revised, the money flowing back into the schemes will be reduced.

Here’s why…

Suppose at the time of exit, the Net Asset Value (NAV) of the mutual fund scheme was Rs 500, and the fund house levied 1% exit load, the valuation of your unit balance will be done at the NAV of 495—after adjusting the exit load.

In other words, if you held 100 units in the scheme, the cost of premature withdrawals in the form of exit loads would be Rs 500.

With the application of GST on the exit loads, the mutual fund will pay a tax of Rs 76 (assuming that was included in the exit load of 1%). In other words, now in place of Rs 500 getting ploughed back in the scheme, only Rs 424 will be added back.

It’s unclear why the government wants to penalise the existing investors for the premature withdrawals of others. Let’s not forget that the redemption pressure on a scheme accentuates a further drop in the NAV if the fund manager is forced to dispose the asset at whatever price it fetches. Perhaps, the finance ministry might want to explain the logic of treating ‘exit loads’ as a chargeable service.

To sum up…

Who lost the investor?—a mutual fund house

Who will be affected because of this other than the mutual fund?—existing investors of the scheme

Who shall receive the incentive?—investors

Who’s benefiting at the cost of everyone else?—government.

Nothing is certain but death and taxes—it’s so right!

Author: PersonalFN Content & Research Team

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