Taxation of exchange-traded funds (ETFs) is not a much-discussed subject, especially, when compared to assessing the tax liability on stocks, mutual funds, real estate, and more. For the unversed, ETFs are not much different from mutual funds except that they can be traded on the stock exchange using your Demat account just like shares.
The commonly available ETFs for Indian investors are:
Index ETFs: So many investors are inclined to allocate money to stocks listed on the index in a particular proportion. The idea of putting money in this ETF investment is to benefit from portfolio diversification as the increase in stock prices results in increased index performance. For example, NiftyBees is an equity ETF that invests in the top 50 listed companies in India. Since the underlying assets are the stocks of listed Indian companies, the possibility of suffering from volatility is much lower.
Gold ETFs: If you want to avoid buying physical gold or avoid the lack of liquidity in gold mutual funds, allocating some money to gold ETFs may be one way to put some money in gold units that you may sell when needed.
In contrast to gold ETFs, which sell units in small denominations and allow investors to access gold through systematic investment plans (SIPs), physical gold investments need substantial capital. Prices of gold ETFs typically follow those of actual gold. The value of ETFs increases as gold prices rise and decreases when gold prices do.
Bank ETFs: Stocks of banks that are listed on the index that the fund tracks are purchased by bank ETFs. Bank equities are very volatile because banks are the hub of the majority of financial operations. Due to their enhanced liquidity and potential for high volatility, bank ETFs enable margin trading for investors. Tracking the price changes of the underlying equities allows traders or investors to take short or long bets depending on the state of the market.
Liquid ETFs: If you are intent on having enough liquidity while investing your money, liquid ETFs can help you earn more returns while taking minimum risks. By putting money in liquid ETFs, you can put money in
- Short-term government securities
- Call money market
- Money market instruments with short maturity tenures.
International ETFs: If you want to invest in foreign securities, you must opt for international ETFs that invest in stocks of hundreds of global companies. As the name suggests, these ETFs invest in foreign securities.
How are these ETFs taxed?
Anything that earns you income is taxed, which means that you cannot shirk away from the liability of paying your taxes on the earnings made from the sale of your ETF units. The taxation of equities ETFs is the same as that of equity shares and equity-oriented mutual funds. It must be held for 12 months in order to be classified as a long-term capital asset, else the same would qualify as a short-term investment. Earnings beyond ₹1 lakh from equity ETFs held for more than a year will be subject to a 10 per cent tax. However, short-term equity ETFs are taxed at 15 per cent.
The benefits of holding for a prolonged tenure are not available for gold, debt, and international ETFs. Post the amendment in the Finance Bill on April 01, 2023, assessing tax liability for gold, debt and international ETFs based on their holding period has become irrelevant since they are now classified as short-term capital assets and, hence, taxed at the existing income tax slab rates.
The recent revision also stipulates that at least 35 per cent of assets must be invested in domestic equity markets to qualify for the indexation benefit of being categorized as a long-term capital asset (holding time greater than three years). This explains why international ETF holders do not gain indexation benefits.
Before you invest, it makes sense to know the tax liability pertaining to that investment. ETF earnings too incur taxes, though the tax liability depends on the kinds of ETFs invested in and their holding period.