Investors may have to bear the brunt of the service tax given the reluctance among mutual fund distributors to absorb the tax.

The Central Board of Excise and Customs had clarified in November 2003 that MF distributors were liable to pay service tax at 8 per cent as announced by the income-tax authorities.

Karvy Consultants, which is also a MF distributor, filed an appeal in the Hyderabad High Court. On March 31, 2004, the HC stayed the implementation of the I-T ruling from February 2004 onwards and asked the government to reply to the petition. The reply was to have been filed by the end of April.

Meanwhile, MF distributors met on April 30 to consider options available to them.

Rajiv Bajaj, director, Bajaj Capital Services, which is also a leading distributor of mutual funds and other financial products, said the service tax "has to be recovered from the service receiver, which are the asset management companies." The AMCs may, in turn, pass it on to the investors, he said.

He pointed out that there was no consensus among distributors on the issue. "There are groups of distributors who are negotiating on their own."

Rajendra Naik, managing director, CentrumDirect Distributors, said: "Worldwide, the investor pays service tax as he is the ultimate user of the service. Moreover, distributors do not have enough margins to pay the tax now."

He added that some solution has to be worked out, suggesting that AMCs can work the service tax in their expense ratios and pass it on to distributors or deduct the tax upfront.

Bajaj said the question of distributors bearing it is not tenable since they operate on thin margins. For debt funds, distributors get margins between 0.2 per cent and 0.5 per cent and for equity schemes, the margins vary between 1 per cent and 1.75 per cent. Absorbing the service tax will dent their profitability severely.

Karvy's petition against the income-tax authorities sought a "stay of levy and collection of service tax on the consideration charged or received for the service rendered" by the company for distribution and marketing of mutual funds.