Taxation of ETFs: How much tax to pay on your Investments?

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.

What are ETFs?

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.

Taxation on ETFs

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:

• Long Term Capital Gains: If you hold your ETF in your portfolio for one year and decide to sell it off, you will be required to pay 10% tax without indexation benefit on a resultant capital gain above INR 1 Lakh.
• Short Term Capital Gains: If you decide to sell your ETFs in under a year, you will be required to pay 15% tax and applicable surcharge and cess on your investments.
• Taxation on Debt and Gold ETFs

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;

• Long Term Capital Gains: In the case of Debt and Gold ETFs, the holding period changes to 3 years; hence if you are selling your ETFs after three years, you will have to pay a  20% tax with indexation benefit on your capital gains.
• Short Term Capital Gains: In this case,  all the capital gains will be added to one’s annual income and then taxed as per the investor’s tax slab, up to 30%.
• Taxation on Dividends

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,

1. Direct credit to investor’s account
2. Reinvestment back into the ETF

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.

Final Words

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.

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