Exchange-traded funds, or ETFs, were launched in India in 2002. Since then, ETFs have become one of the most popular investment options 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.
As discussed before, ETFs are funds that invest in stocks and follow the passive strategy and track the underlying index. 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 through which investors earn money by investing in ETFs:
Because ETF is a mix of securities, the dividend that you earn by investing in independent stocks is also applicable to ETFs.
Some fund houses provide an option to investors to either credit dividends into their accounts or reinvest in the ETF and look out for higher returns at the time of sale. These dividends are considered for tax purposes.
When you trade ETFs 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 your investment period and if you sell the fund for a profit, the profits are defined as capital gain and are considered for tax purposes.
This tax is called the dividend distribution tax (DDT). Before FY 2020-2021, a DDT of 15% was applicable to all the dividends paid to investors. From FY 20-21, the concept of DDT was abolished, and the income from dividends is added to the investor’s annual income.
The tax rate applicable was the same as the income tax slab rate of the investor.
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.
These are exchange-traded funds that majorly invest in equities or related investment instruments. As you might have already guessed, the tax structure for these would be very similar to the capital gains made from individual stocks.
Capital gains are considered short-term capital gains if the income arises from the sale of stocks that were on hold for less than a year. Likewise, capital gains are considered long-term capital gains when the holding period is greater than 1 year.
The tax structure is similar for gold, debt, and other ETFs. But, the long-term and short-term capital gains are defined in this case.
Capital gains are considered short-term capital gains if the income arises from the sale of stocks that were on hold for less than 3 years. Likewise, capital gains are considered long-term capital gains when the holding period is greater than 3 years.
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 are more liquid investments than mutual funds.
Although these are excellent passive investment instruments, it is always recommended to trade based on your investment goals.
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