How are ETFs Taxed in India?

Exchange-traded funds, or ETFs, were launched in India in 2002. Since then, ETFs have become a popular investment instrument for many investors because of their fundamental structure.

ETFs are a basket or a portfolio of diversified securities that can be traded on the stock exchange. The majority of ETFs track an underlying index and can be divided into three categories – equity, gold, and others.

Regardless of the type of investment you choose, it is crucial to understand the tax structure on the income gain generated by the investment. This article discusses the tax laws for ETFs in India.

Different Avenues to Make Money through ETFs 

ETFs follow the passive strategy. These instruments can be traded on a stock exchange like any other stock, and their price is determined by supply and demand in the securities market.

There are two ways in which investors earn money by investing in ETFs:

1) Income through Dividends

Because ETF is a mix of securities, including stocks, investors earn through the dividends earned from these stocks.

Some fund houses provide an option to investors to either credit the dividends into their accounts or reinvest in the ETF, for higher returns at the time of sale. These dividends are considered for tax purposes. 

 2) Income through Capital Gains

When ETFs are traded on a stock exchange, the buying and selling price is determined by the supply and demand in the market. If the overall price of the fund increases in the investor’s investment period and if it is sold for a profit, the profits are defined as capital gain and are considered for tax purposes.

Taxes on Various Incomes Through ETFs

• Tax Structure on Dividend Income 

This tax is called the dividend distribution tax (DDT). Before FY21, a DDT of 15% was applied to all the dividends paid to investors. From FY21 onwards, the concept of DDT was abolished, and the income from dividends was added to the investor’s annual income.

The tax rate applicable was the same as the income tax slab rate of the investor.

• Tax Structure on Capital Gains

Capital gains can be long-term or short-term, and the tax structure for these differs accordingly and is also conditional on the type of ETF. 

For Equity ETFs

Equity ETFs majorly invest in equities or related investment instruments. Short-term or long-term capital gains tax applies to these instruments depending on the holding period, i.e., 

• Short-Term: Less than 12 months
  
• Long-Term: 12 months and more

For Gold & Silver ETFs

• Short-Term: Less than 12 months
  
• Long-Term: 12 months and more

For Debt ETFs

Debt ETFs are taxed at the investor's income tax slab rate, irrespective of the holding period, for units bought on or after 1 April 2023. 

Wrapping Up

As an investment option, exchange-traded funds have evolved as one of the most preferred investment options for investors. Not only are they diverse, but they are also easy to trade and more liquid than mutual funds.

Although these are excellent passive investment instruments, it is always recommended to trade in them based on your investment goals.