MUMBAI: A new expense ratio rule from India's market regulator could cut the income of small mutual fund distributors (MFDs) by as much as a fifth, prompting an industry body to warn of an uneven playing field.

In a letter dated 12 March, the Foundation of Independent Financial Associates (FIFA) asked the regulator to revisit key elements of the revised expense ratio framework, saying it is built on a flawed assumption that all distributor payouts attract 18% goods and services tax (GST).

That assumption, it said, does not hold for a large part of the industry. Nearly half of India's distributor base either falls below the GST threshold or operates under the composition scheme, leading to a lower effective tax incidence.

Distributors with annual turnover of up to ₹50 lakh can opt for the composition scheme, under which they pay a lower 6% tax but cannot issue GST invoices or claim input tax credit. Those with turnover below ₹20 lakh are not required to register for GST and do not charge the levy.

FIFA said the shift to a base expense ratio (BER) that excludes statutory levies risks reducing payouts for these distributors purely due to the tax treatment. It has asked the regulator to mandate brokerage parity for exempt and composition scheme distributors so their net earnings are not hit by the move from an inclusive to an exclusive expense ratio structure.

"The cost to the scheme of maintaining such parity is estimated at approximately 1-2 bps (basis points) of total AUM (assets under management), whereas the income impact on the individual small MFD is 15-20%," the industry body said in its letter.

Pressure on smaller distributors

Mint reported last week that the Securities and Exchange Board of India's (Sebi) overhaul of the total expense ratio (TER) framework could significantly disrupt the mutual fund distribution landscape, particularly for smaller players who account for roughly half of the industry's ₹81 trillion assets.

Many of these distributors, particularly those not registered under GST, may be pushed to partner larger platforms to manage compliance and sustain operations.

"A majority of the industry is not GST registered as of now," Kartik Sankaran, a mutual fund distributor with Happyness Factory, which handles assets of more than ₹4,800 crore, had told Mint earlier.

"There is a very long tail of distributors who do very few transactions in a year," he said. "A small distributor who works with 15 AMCs will have to file 15 GST returns. Platforms can help them with this as they may not have the operational capacity or capital to do the same."

Under the new rules, a fund house's BER, charged to investors, must exclude statutory levies such as GST and Securities Transaction Tax. The rules come into effect from 1 April.

Sebi did not immediately respond to Mint's queries.

FIFA has also objected to a change in how GST is paid by asset management companies. Under the emerging system, brokerages would be paid excluding GST, with the tax component released only after distributors submit invoices. FIFA said this has no statutory or regulatory basis.

It has urged the regulator to direct the Association of Mutual Funds in India (Amfi) to continue with the earlier practice of paying brokerage inclusive of GST upfront, followed by invoice submission.

The industry body also said any reduction in BER beyond the GST adjustment should be absorbed by asset management companies rather than passed on to distributors, arguing that fund houses are better placed to bear the cost given their scale.

It has further called for a review of an existing Amfi guideline that bars an increase in distributor commissions on existing assets under management, saying the restriction prevents distributors from benefiting even where the revised TER structure allows higher expense limits.