How ETFs Are Taxed in India (FY 2025-26)?

Exchange traded funds are those who invest their pool of funds in a basket of investments. Unlike mutual funds, these are actively traded on the stock exchange. Usually, Exchange traded funds derive the return, equivalent to the underlying investment. Since they are publicly listed, period of holding and taxation differs from that of mutual funds.

ETF Tax Rates at a Glance

The following table presents tax rates for different forms of ETF. Depending on equity orientation, the tax rates differ.  (Section references are made for Income Tax Act, 1961)

Dividend Taxation for ETF

• Exchange Traded Funds earn dividend income, especially the equity-oriented ones. Investors can opt for dividend pay-out option, in which dividend is paid out to unit holders on a periodic basis, or reinvestment option, where the dividends are re-invested. 
• In both the cases, dividend income is taxable under the applicable income tax slabs. TDS is deducted against dividend income at 10%, when the dividend income exceeds ₹10,000 during the financial year.
• Investors need to observe here, the dividend income need not be excluded from taxation, just because it is not yet paid out, under the reinvestment plan.
• Dividend income needs to be reported under the head ‘Income from other sources’. Relevant disclosure needs to be made in ‘Schedule OS’ of ITR.
• Field for dividend income is available in all the ITR forms , (ITR-1 to ITR-4). 
• Therefore, your earning of dividend income usually does not play a critical role in choosing the right ITR form in many cases.
• However, when you have invested in international ETFs, dividend income from the same needs to be reported in ‘Schedule FSI’ (Foreign Source Income), when the assessee is a Resident - Ordinarily Resident (ROR).
• For ROR status, The investment value, and other details needs to be disclosed under ‘Schedule FA’ (Foreign assets) as well.

Securities Transaction Tax (STT) on ETFs

• All the securities publicly traded on the stock exchange, are subject to Securities Transaction Tax. 
• The seller is responsible for payment of STT on ETFs, at 0.001% of the value of the securities. However, STT is not a deductible expense in capital gain calculations.
• STT also plays an important role in determination of whether section 112A and 111A is applicable on the ETF under consideration. 
• As per the provisions of section 112A and 111A of the Income Tax Act, 1961, long term and short term capital gains on sale of equity oriented funds are taxed at 12.5% and 20% respectively, only when the securities transaction taxes are paid. 
• Generally speaking, on purchase and sale of securities, STT is already deducted by your stock broker and remitted to the government. 
• It is necessary to ensure that STT is deducted on every equity ETF transaction, to qualify for beneficial tax rates under section 112A and 111A of the act.

How to Set Off ETF Capital Losses?

• In most of the cases, profits from the sale of exchange traded funds are treated as capital gains. 
• On the other hand, losses from ETF sale can be used for set-off against capital gains from other assets. 
• While long term capital loss can be set off only against the long term capital gains, short term capital losses can be set off against both short term and long term capital gains.
• Unutilised losses can be set-off and carried forwarded to the subsequent 8 assessment years for future set-off, if the return of income is filed within the due date.
• In some cases, tax loss harvesting techniques can be adopted, to reduce the incidence of taxable gains. However, it is to be noted that aggressive tax loss harvesting strategies may be flagged for scrutiny, and may attract notices.

How to Report ETF Gains in Income Tax Return (ITR)?

• Capital Gains on sale of ETF is reported in ‘Schedule CG’ (Capital Gains) in the ITR forms. 
• Choice of the correct ITR form depends on the duration for which the security is held, its equity orientation, and the quantum of capital gains.
• If you have long term capital gains on sale of equity oriented exchange traded fund, within ₹1.25 lakhs, such gains are exempt and still can be reported under form ITR-1.
• In the other cases, capital gains are reported under form ITR-2. If you want to carry forward the losses to the future assessment years, you cannot opt for ITR-1.
• It is important to include all the expenses related to transfer (except STT), like brokerage, clearing charges, SEBI turnover charges, etc. This way, capital gains can be reduced, leading to a reduction in taxation.
• In certain cases, you can even qualify for tax exemption, if your capital gains fall within ₹1.25 lakhs because of deducting expenses for transfer appropriately.

ETF Taxation for NRIs

• NRIs attract TDS implications on sale of ETFs. The following table shows TDS rates for various types of income from ETF.

Note: Applicable surcharge and cess is deducted in addition to the TDS rates mentioned above for NRIs. However, you can claim refund of excess TDS deducted while filing ITR.

• Essentially, wherever double tax implications occur, NRIs can claim the benefits under DTAA, as per section 90 and 91 of the Income Tax Act, 1961.
• Tax residency certificate, Form 67 are some of the important documents to claim Foreign Tax Credit.

Final Word

Understanding the tax treatment of ETFs is essential for accurately calculating your tax liability and maximizing post-tax returns. The taxation of ETFs depends on factors such as the type of ETF, holding period, and the nature of gains earned. By keeping track of purchase and sale details and being aware of the applicable tax rates, investors can avoid errors in tax filing and make more informed investment decisions.