If you’re one of the people who constantly wander in the woods of the market to find treasures, you must have heard of Exchange Traded Funds or ETFs.
ETFs are a new age investing channel which can be thought of as a combination of Mutual Funds and Stocks, cherry-picking the best of both.
However, as with any investment avenue, ETF investments attract capital gains, ultimately leading to taxes– a word that puzzles even the most experienced investors. Well, the good news is that we’ve got you covered. So, stay with us while we try to simplify the taxation of ETFs for you.
Exchange-traded funds or ETFs were first introduced in the Indian Stock market in 2002. ETFs allow an investor to take benefits of mutual funds while exercising the liberties associated with stocks.
ETFs provide one with expert management for a small fee, thus resembling mutual funds. At the same time, the options to sell and buy without worrying about the exit load give it the characteristics of ordinary stocks.
Enough of the premise. Let's jump to the big question. How are these investment instruments taxed? As in the case of Mutual Funds, the ETFs are taxed according to their composition.
Taxation on Equity ETFs:
Equity ETFs are the most popular ETFs traded on the stock market because they directly invest in stocks of different companies,
The capital gains arising from these ETFs are taxed as follows:
These ETFs are different from Equity ones. They only invest the money in Debt Instruments (bonds) and Gold related instruments (Digital Gold, Stocks of gold mining companies, RBI monetisation scheme). This translates that these ETFs will be taxed at a different rate than the previous. The taxation scheme followed here is;
With equity ETFs, there comes an added benefit of getting dividends from companies who decide to share their profits with the investors once in a while. In the case of ETFs, this dividend can be credited in two ways,
For case (2), the taxation will be in the form of capital gains, so there is no need to worry about that part.
But if ETFs do credit the dividends income in your account, then there was a Dividend Distribution Tax (15%) which has now been abolished. And under the new rules, the income from dividends will be added to your income and taxed as per your income tax slab. In addition to this, Mutual fund companies have to mandatorily deduct a TDS of 10% if the dividend income exceeds Rs 5000.
ETFs are a great source of income that makes the best use of the environment of Stocks and Mutual funds. And with great investment opportunities come taxes, so we hope you are aware of the same. Happy Investing, and see you in another blog.
Ans. Capital Gains simply put is the profit that arises due to the sale of an asset.
Ans. The real value of money changes due to inflation and this change gets pronounced in the case of long term investments. Hence, it is only logical to tax the real value of money after applying for the indexation benefit, also called inflation-adjusted amount.
Eg.- An amount of ₹10,000 12 years ago would be equivalent to ₹23485 in today’s money. Now let’s say this money grows at a rate of 11.25%, this would result in a net investment value of ₹35,942.
Now, the net capital gain = ₹25,942
However, after the indexation benefit, capital gain = ₹12,457.
Now, this ₹12,457 would be taxed as per the applicable rate and not the previous ₹25,942.
This provides huge tax relief to long term investors.