An Exchange Traded Fund (ETF) may be defined as a basket that contains securities like shares, bonds or commodities. ETFs are traded on an exchange, just like stocks. ETFs offer combined benefits of mutual funds and listed stocks. They also help an investor diversify their portfolio and can be easily traded.
Like every investment instrument, ETFs also come with tax liability arising out of the income that is generated and you, as an investor, need to be aware of the taxes on ETFs in India.
How is the ETF taxation in India?
ETF taxation in India follows separate tax slabs for different categories of Exchange Trade Funds. It is important to know the categories in order to understand the taxation norms. ETF categories are as follows:
- Equity ETFs – These invest in equity or related instruments
- Debt ETFs – These invest in securities that generally have a fixed income
- Gold ETFs – These ETFs invest in gold
- International ETFs – These invest in the international market after tracking indices from international stock markets
There are two ways of earning profit from an ETF – from dividends and from capital gains. An ETF is a combination of different types of securities. Therefore, independent investment with each of the constituent securities may earn a dividend for the investors.
Apart from this, ETF units may be traded on a stock exchange’s secondary market. Whenever a unit of an ETF is sold at a higher price than the cost price, the profit arising out of the deal is considered as capital gains. Therefore, it is a taxable income depending on the securities that constitute the ETF.
ETF taxation rules – For dividends
In the last fiscal year, a dividend distribution tax (DDT) of 15 percent was charged on all dividend incomes. From the current fiscal year, DDT has been done away with. Now, the dividend income gets accumulated with the investor’s total income and gets taxed as per the slab rate.
ETF taxation rules – For capital gains:
- Tax treatment for equity ETFs –
In case an equity ETF is held for more than twelve months and then sold for profit, it is deemed as long term capital gain. In this situation, tax is exempted up to capital gains of Rs. 1 lakh. If the gain is more than Rs. 1 lakh, it is to be taxed at the rate of 10 percent under Section 112A of the Income Tax Act, 1961.
If the equity ETF is held for less than twelve months, it is categorised as short term capital gain. Here, the provisions of Section 111A of the Income Tax Act, 1961 are applicable. Tax at the rate of 15 percent along with surcharge and additional cess will be levied on the gains.
- Tax treatment for debt, gold and international ETFs –
If any of the above ETFs is held for more than thirty-six months and then sold for profit, it is categorised as long term capital gain and taxed at the rate of 20 percent with indexation benefits.
In case any of these ETFs are held for less than thirty-six months and sold for profit, it is taken as short term capital gain. In which case, it is added with the total income of the investor and taxed as per their slab rate.
While selling ETFs, there may be a case where the investor has to book a loss. In such a situation, the tax liability can be reduced by setting off capital losses against capital gains.
Making investment decisions – Is ETF for you?
Managing and growing one’s funds could be a bit challenging for quite a few investors. If you are one such investor, opting for a financial advisory service provider would be a prudent choice. Exploring options with the help of an advisor could help you in devising an investment strategy that would be in line with your financial goals and risk appetite.