How are ETFs are Taxed in India?

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How are ETFs are Taxed in India? | WealthDesk

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Investing in ETFs is a great way to diversify your portfolio and take advantage of tax efficiency. ETFs or Exchange Traded Funds are considered a type of security that tracks an index, commodity, or sector and they are bought and sold by consumers just like any other regular equity. It may also track anything from a single asset to several assets in order to follow certain investing plans.

ETFs are of four different types namely, Index ETF, Gold ETF, Thematic or Sectoral ETF and, International ETF. Index ETF tracks indexes like Sensex or Nifty; Gold ETF tracks the current market price of Gold; Thematic or Sectoral ETF tracks a specified theme or sector and; International ETF tracks international investing options. Skilled traders are aware of the tax benefits of ETFs, which is why they are so proactive in their tactics. This article is focused on helping you understand how ETFs are taxed.

How are ETFs taxed?

ETF and Mutual Funds receive different tax treatments due to the complex structure of the former. Exchange-Traded Funds trigger taxable events only when it is sold.

Index and Thematic ETFs are taxed as equity funds. In order to receive long-term capital gains treatment, you have to hold on to them for more than a year.  In that case, you will be taxed at the rate of 10% without the amount of indexation benefit. Holding on to ETFs for anytime less than one full year will result in a short time capital gains treatment and you will be taxed at 15%. Long-term capital gains of up to 1,00,000 INR are exempt from taxation.

On the other hand, International and Gold ETF Taxation are done as non-equity funds. To get long-term capital gains treatment, you have to sell ETFs after a period of 36 months. You will be taxed at 20% with the amount of indexation benefit plus any additional cess. In case of short-term capital gains treatment of fewer than 36 months, you will be taxed according to the current tax slab. 

Exceptions

There are three major exceptions to the ground taxing rules of ETFs. They are listed as under:

  • Currency ETFs: Currency ETFs are a type of exchange traded fund which tracks the current relative value of a currency or a set of currencies. It does not receive the benefit of long term capital gains even if you hold on to it for several years. As currency ETFs trade in pairs of currencies, taxation authorities may presume that these exchanges occur in short periods. 
  • Futures ETFs: Futures ETFs are a type of exchange-traded fund which invests in futures contracts in order to mirror the performance of an underlying index. Regardless of the time, the ETF was held for; gains or losses on Futures ETF are taxed as 40% short-term capital gains and 60% long-term capital gains. 
  • Metals ETFs: Metals ETFs are a type of exchange traded fund which invests in physical metals which are considered as ‘collectibles’ for tax purposes. If you make a short-term gain from these ETFs, it will be taxed as regular income, but if you make a long-term gain from over a year, you will receive a higher tax rate of 28%.

Tax Planning Strategies with ETFs

The following are some effective Tax Planning strategies that help you to keep your tax bill low while using ETFs. 

  1. Closeout losses before a year: If you know a position will lose money, it’s a good idea to close it out right before the end of the year. It permits you to achieve long-term capital gain treatment for only your lucrative holdings, lowering your tax obligation.
  2. Buy an identical ETF: If you believe a certain position will increase in value over the next few months, but the market is pulling sectors down, it is a good idea to sell that ETF and replace it with one that has a comparable but different index. In this manner, you’ll maintain your profitable sector while only losing money on the one you sold at a loss.
  3. Purchase Sector ETFs: If you have a position that is now losing money but is expected to rise in value over the next year, you should sell the ETF and buy sector ETFs to maintain your exposure to the sector. 

Final Thoughts

ETFs, or Exchange Traded Funds, are a wonderful addition to anyone’s portfolio since they give diversification in investing and a lot of tax benefits. By investing in them and preparing year-end strategies, a competent investor may easily optimize his or her gains. In respect to capital gains, ETF or Mutual Funds goes in the favor of the latter as it is shown that Mutual Funds generally provide more capital funds. ETFs, on the other hand, are frequently recommended to investors wanting to save money on taxes. You may save even more money on taxes as an investor by selling positions that are losing value at the end of the year and receiving long-term capital gain treatment on those that are profitable and increasing in value. 

You can also invest in Tax Saving ETFs that do not follow the ETF Tax regulations, such as Currency ETFs, Future ETFs, or Metal ETFs. Tax on Gold ETFs and International ETFs are provided as non-equity ETF while Index and Sectoral ETFs are treated as an equity fund for ETF Taxation in India. As for Tax-free ETFs, Municipal Bonds are tax-free since you’re investing in a local government. Municipal Bonds can provide you with tax-free ETF dividends.

At WealthDesk, experienced advisors analyse the best ETFs in India and help investors with their ETF investments. It also allows investors to make informed decisions about different ETF stocks and shares based on their targeted risk and return considerations.

FAQs

How do I lower my tax liability on ETFs?

One common practice is to close off money-losing holdings towards the end of a year. Only profitable holdings will remain in your portfolio for the foreseeable future, allowing you to reap long-term capital gains. This method helps you to lower your tax liabilities.

Can I purchase and sell an ETF on the same day?

Yes. ETFs can be purchased and sold on the same day.

Which is more tax-efficient? ETF or Mutual Fund?

ETFs are much more tax-efficient than Mutual Funds because of their complex structure.

What are the costs of investing in an ETF?

The buy-sell spread and brokerage fees are additional charges that investors face when buying or selling ETF units. These fees are not levied by the ETF provider, but rather by the market maker and the investor’s stockbroker respectively.