Barring some bigger towns, penetration of mutual funds in India has been abysmally low. While the Government has been seeking to increase retail participation in capital markets, a recent decision of levying 14% service tax on mutual fund distributors is likely to discourage the retail participation. Unfortunately, mutual funds still remain a 'push' product (which is not actively bought) in India.

In the Union Budget 2015-16, exemption given to the mutual fund agents and the distributors from service tax was withdrawn and it was decided that, service tax shall be levied on reverse charge basis at the rate of 14%.

Now if you think, it's a matter between mutual fund houses and the mutual fund agents and distributors; you are missing the intricacies. You shouldn't forget that beneficiaries of services usually bear the service tax. Mutual fund distributors and agents argue that they are merely the conduit between mutual fund houses and investors and thus they shouldn't be subject to the levy of service tax. As described by the Foundation of Independent Financial Advisors (FIFA), effective rate of service tax levied on mutual fund agents and distributors, works out to be 16.28%. FIFA argues that, mutual fund houses may deduct Rs 14 per Rs 100 paid towards commissions. Therefore, effectively, mutual fund distributors would end up paying Rs 14 as a tax on the service rendered.

So who would bear the burden of service tax?
In principal, it may not be very appropriate to continue charging mutual fund distributors service tax. If mutual funds decide to pass it on to investors, there is a hurdle. The Securities and Exchange Board of India (SEBI) has capped, Total Expense Ratio (TER) that can be charged to investors. Management fees charged by the mutual fund houses and service tax paid on it, is already being passed on to investors. Therefore it is unlikely that fund houses may be able to charge investors any amount further, unless SEBI allows them to do so by raising the limit of TER.

PersonalFN is of the view that, while Government expects to collect nearly Rs 800 crore of revenue from levy of service tax on mutual fund distributors, industry may suffer. It is believed that if income of distributors takes a hit, they might lose interest in promoting mutual funds and even servicing their clients. PersonalFN believes the Government and the regulator have to intervene in the matter providing clarity on who should bear the burden of service tax. If SEBI allows mutual funds to pass it on to investors, investors must be prepared to shell out more.

How you as an investor can save on costs?
PersonalFN believes you should opt for 'direct plans' provided by the mutual funds as they are more cost effective. Please don't forget that, while you opt for direct plans, you would have to decide on your own as to which funds to invest in. If you do not have time to do thorough research, you may consider opting for unbiased mutual fund research services provided by PersonalFN.

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