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Skin in the game order knots MF employees’ income tax

Skin in the game order knots MF employees’ income tax

03 May 2021

MUMBAI: The market regulator’s “skin in the game” directive is going to make salary and tax calculations complicated for key executives at fund houses.

The Securities and Exchange Board of India (Sebi) last week ordered that fund houses pay at least 20 per cent of the total compensation of fund managers and other key executives in units in mutual fund (MF) schemes they oversee. The rule is aimed at aligning the interests of the people managing the funds with those of the investors.

Since the value of this portion of the compensation will be market-linked and changing on a daily basis, it is unclear how it will be taken to issue the units and calculate the monthly tax outgo of these executives. If a fund manager is handling several schemes, it becomes even tougher to compute the percentage of salary to be given in fund units and the tax on those.

Many top executives at fund houses have approached their tax advisers to understand the impact, said fund industry insiders and tax experts. There are no specific guidelines on this yet and tax practitioners have informally reached out to the tax department to understand the implications. As of now, they will have to interpret the current guidelines to suit this situation, experts said.

“When key employees get the mutual fund units, the market value will be taxed as salary without any cash in hand. The cost base will be available only when the MF units are sold or redeemed,” said Yashesh Ashar, a partner at accounting firm Bhuta Shah & Co.

Taxing Dividend, Distribution Income

More complications will arise if the fund manager earns dividend or distribution income on the mutual fund units he holds — over when and how to tax this. This could be added to salary income and taxed at full rate, said Ashar.And, when the executive is handling multiple schemes (exchange-traded, index and oversight funds, along with existing close-ended schemes, are excluded), contributions are to be done as per the weighted average of assets under management, said Amit Maheshwari, a partner at tax consultancy firm AKM Global. “This could result in periodical rebalancing and, hence, lead to tax outflow,” he added.These employees must hold the units for at least three years, even if they leave the fund house, as per the rule. When they redeem the units after the lock-in period, it could create further issues.

When the employee gets the units, the market value could be taxed as salary, said experts. But how to take the base, or the salary paid in fund units during the full period, to calculate tax at the time of redemption of the units will be a challenge, as this amount will likely be different every month.Tax experts said only the gains on the base should be taxed at that stage, at the long-term capital gains tax rate of 10 per cent.It is also unclear who all at fund houses, or asset management companies, will come under the new Sebi regulation. “The term ‘key employees’ of AMCs has been widely defined to include compliance officers, heads of other departments, those who report to the CEO and even individuals who have no direct role in investments by mutual funds schemes,” said Ashar.