Tax Implications of ETF Investing

Exchange-traded funds, or ETFs, are gaining popularity among investors. They are affordable to buy and sell, and also diversify at a stroke. Although most investors tend to focus on returns and expenses, one factor is often overlooked: taxation. The taxation of ETFs may directly impact your actual profits. Whether investing in equity or debt, or international ETFs, one can make better decisions regarding the post-tax results by understanding how each can be treated under Indian tax laws. This article simplifies the major taxation provisions given to various types of ETFs.

What Are ETFs?

ETFs are financial products that trade on stock markets just like normal stocks. They follow a performance of an index, commodity, sector, or other asset. These are the broad categories of ETFs:

1. Equity ETFs: These are ETFs that would help in investing in the stock market and tracking the principal indices of the country (such as Nifty 50 or Sensex), giving a chance to the investor to invest in the equity market.
2. Debt ETFs: Debt ETF funds are put in fixed income assets (government bonds or corporate bonds) which are less volatile with a steady rate of returns as compared to stocks.
3. Commodity ETFs: These commodity ETFs follow the value of goods such as gold or silver. The Gold ETF is a common example.
4. International ETFs: Such ETFs will invest in foreign markets, tracking international indexes like the Nasdaq-100, and they will provide exposure to foreign stocks.

Recommended Read: How to Invest in Gold ETF?

Tax Implications of ETF Investing

Taxation is one factor that should be understood when dealing with ETFs to create better investment options. The taxation of ETFs mainly rests upon two variables, the type of ETF (equity, debt, commodity, or international) and the holding duration of the investment. Both types also have their short-term and long-term capital gains regulations and this may have a direct effect on your overall gains. Let us examine the tax treatment of the types of ETFs.

1. Taxation of Equity ETFs

Equity ETFs invest primarily in domestic equities and are treated as equity-oriented funds if at least 90% of their assets are in stocks.

• Short-Term Capital Gains: Short-term capital gains realised on the sale of units within a period of 12 months are treated as short-term capital gains and are taxed at a uniform rate of 15 per cent under Section 111A of the Income Tax Act.
• Long-Term Capital Gains: If the Long-term profits are more than ₹1 lakh in a year then it is taxed @ 10 % with no indexation.

Illustrations: If you earned ₹1.5 lakh as long-term capital gains from equity ETF in a year, the tax-free amount is ₹1 lakh and the remaining ₹50,000 is taxed at 10%.

2. Taxation of Debt ETFs

Debt ETFs invest in fixed-income instruments like government or corporate bonds and are treated as non-equity funds for tax purposes.

• STCG (Held ≤ 36 months): Gains are added to your total income and taxed as per your applicable income tax slab.
• LTCG (Held > 36 months): Gains are taxed at 20% with indexation, which adjusts the purchase cost for inflation, helping reduce tax liability.

Example: In case you redeem your debt ETF which you held for 3 years, the indexed cost will be taken into account when calculating the ultimate capital gains, resulting in lower taxable gains and reduced tax liability.

3. Taxation of Commodity ETFs

Commodity ETFs, such as Gold ETFs, track the price of physical commodities. They are also classified as non-equity funds.

• STCG (Held ≤ 36 months): Gains are taxed as per your income slab rate.
• LTCG (Held > 36 months): Gains are taxed at 20% with indexation, just like debt ETFs.

Example: Suppose you invest in a Gold ETF and redeem it after 3 years. The purchase price is adjusted using the inflation index, and the final gain is taxed at 20%.

4. Taxation of International ETFs

International ETFs invest in overseas markets and are also treated as non-equity funds for tax purposes.

• STCG (Held ≤ 36 months): Gains are added to your income and taxed at your applicable slab rate.
• LTCG (Held > 36 months): Gains are taxed at 20% with indexation.

In addition, dividends received from international ETFs may be subject to foreign tax withholding, usually in the range of 10% to 25%, depending on the tax treaty between India and the country of origin. Investors may be able to claim credit for foreign tax paid when filing their income tax returns, provided proper documentation is maintained.

5. Taxation on Dividends from All ETFs

The Dividend Distribution Tax (DDT) has also been eliminated since the financial year 2020-21. As of now, any dividends gained on any kind of ETF are all:

• Taxed in the hands of an investor at their applicable income tax slab rate.
• One can be taxed under TDS @ 10 per cent, provided that the aggregate amount of dividend received on a specific ETF is more than ₹5000 during a financial year.

Example: Say, for instance, that you earn an ETF dividend of ₹6,000. In this case, TDS will be an amount that equals 10% of the total amount, i.e. ₹600. You should declare this income under the Income from Other Sources while filing your Income Tax Return (ITR).

Tax Filing and Compliance

While doing tax filing for ETF investments, always verify any TDS on dividends by means of Form 26AS or AIS. Capital gains from selling ETF units should be reported under Schedule CG in your income tax return (ITR-2 or ITR-3), while dividend income goes under Schedule OS.

Tips to Maximise Tax Efficiency

Follow these simple strategies to lower your tax burden and improve overall returns from ETF investments:

1. Hold for the Long Term

If the equity ETFs are held for over a period of one year, then the tax rate of 10% can be profited since there prevails a tax exemption amount of ₹1 lakh or a specific term of 12 months for long-term capital gain.

2. Apply Indexation of the Non-Equity ETFs

In the case of debt and commodity ETFs that have been held for over a period of three years, taxpayers can avail the indexation benefit. Indexation decreases taxable capital gain by adjusting the cost of acquirement of the investment by the rate of inflation. This decreases the total tax outgo while offloading ETFs of this kind after the required amount of time for holding.

3. Tax-Loss Harvesting should be used

If there has been any underperformance of an ETF, it can be sold before the financial year-end. The losses booked in this way can be set off against profits from other investments, thereby reducing the overall taxable income. This strategy, known as tax-loss harvesting, helps in optimising the tax outgo while maintaining a balanced investment portfolio.

4. Tax-adjusted Diversification

Blend funds of various forms of ETF that are taxed differently. The risk of equity ETFs can be hedged with tax-efficient debt or commodity ETFs to strike a balance between risk and efficiency, after taxes.

Make ETF Investing Work Smarter for You

ETFs are both cost effective and flexible to invest but it is important to know how such products are taxed to make informed financial decisions. The taxes imposed on each category of ETF, be it equities, debt, commodities, or foreign, depend on the duration of holding and the kind of asset it represents. Tax saving is possible using investment holdings that are held over a long term; tax saving options of indexation are possible to the greatest extent and also through tax-saving strategies of tax-loss harvesting. With proper planning, tax-efficient investing could be easy.

• Author: Religare Broking
• Last Updated: October 1, 2025