How Capital Gains Tax Differs Across ETFs, Equity Shares, and Mutual Funds
Taxation of Securities for Assessment Year 2026–27
As India’s financial markets deepen and diversify, investors today have access to a broad spectrum of securities beyond traditional equity shares. These include equity and non-equity Exchange Traded Funds (ETFs), domestic and international mutual funds, overseas equity investments, and Indian funds investing in foreign assets.
While these instruments may appear similar from an investment perspective, their tax treatment under the Income-tax Act, 1961 varies significantly. A clear understanding of the nature of each security, the applicable holding period, and the relevant charging provisions is therefore essential for effective tax planning.
Statutory Framework Governing Capital Gains
Section 2(42A): Meaning of Short-Term Capital Asset
Section 2(42A) of the Income-tax Act defines what constitutes a short-term capital asset by prescribing holding periods for different classes of assets. Any capital asset held for a period shorter than the prescribed threshold is treated as short-term, and gains arising therefrom are taxed accordingly.
Key holding period rules are as follows:
Immovable property (land, building, house property): Short-term if held for less than 24 months.
Equity shares, listed securities, equity-oriented mutual funds, and units of UTI: Short-term if held for 12 months or less.
Unlisted shares and immovable property: The holding period for long-term classification was reduced from 36 months to 24 months with effect from 2017, providing relief to taxpayers.
This provision forms the foundation for determining whether gains are taxed as short-term or long-term.
Section 50AA: Deemed Short-Term Capital Gains for Specified Assets
Section 50AA, introduced by the Finance Act, 2023 and expanded by the Finance (No. 2) Act, 2024, brought a fundamental shift in the taxation of certain investment instruments.
Under this section, gains arising from:
Market-Linked Debentures (MLDs), and
Specified Mutual Funds (mutual funds having not more than 35% exposure to domestic equity)
are deemed to be Short-Term Capital Gains, irrespective of the holding period. Such gains are taxed at the applicable slab rate, eliminating the benefit of long-term capital gains taxation and indexation.
In practical terms, this provision covers:
Debt mutual funds
Gold, silver, gilt, and liquid funds
Fund of Funds
International mutual funds and ETFs listed in India
Certain unlisted bonds and debentures redeemed or matured on or after 23 July 2024
As a result, investors in these instruments face taxation at marginal rates rather than concessional LTCG rates.
Section 112A: Long-Term Capital Gains on Equity-Oriented Investments
Section 112A governs the taxation of long-term capital gains (LTCG) arising from:
Listed equity shares
Equity-oriented mutual funds
Units of business trusts
Where Securities Transaction Tax (STT) conditions are satisfied, LTCG exceeding ₹1.25 lakh in a financial year is taxed at 12.5% (without indexation).
STT conditions:
For listed equity shares, STT must be paid on both purchase and sale, subject to specific exceptions such as IPOs, FPOs, bonus issues, rights issues, ESOPs, and buybacks, as notified by CBDT (Notification No. 60/2018).
For equity-oriented mutual funds and business trusts, STT is required only at the time of sale.
Taxation of ETFs: At Par with Mutual Funds
An Exchange Traded Fund (ETF) is legally a mutual fund that trades on stock exchanges like an equity share. SEBI categorises ETFs as passive investment vehicles designed to replicate an index, commodity, or basket of securities.
Despite operational differences—such as intraday trading, demat holding, and exchange-based transactions—ETFs are treated at par with mutual funds for income-tax purposes. Accordingly, their tax treatment depends entirely on whether they qualify as equity-oriented or specified mutual funds under the Act.
Key Takeaway on Specified Mutual Funds
Any domestic mutual fund or ETF with less than 35% exposure to Indian equity qualifies as a specified mutual fund. Gains from such funds are always treated as short-term capital gains under Section 50AA and taxed at slab rates, regardless of the holding period.
Comparative Tax Treatment of Securities (Post 23 July 2024)
| Nature of Security | Holding Period | Tax Rate | Applicable Provision / Remarks |
|---|---|---|---|
| Listed domestic equity shares / equity mutual funds (STT paid) | ≤ 12 months | 20% | Section 111A |
| Listed domestic equity shares / equity mutual funds (STT paid) | > 12 months | 12.5% (above ₹1.25 lakh) | Section 112A |
| Debt, gold, silver, gilt, liquid mutual funds or ETFs (listed in India) | Any period | Slab rate | Section 50AA |
| International ETFs listed in India (e.g., Hang Seng Tech ETF) | Any period | Slab rate | Section 50AA |
| International equity / ETFs listed outside India (e.g., US stocks) | ≤ 24 months | Slab rate | Sections 48 & 112 |
| International equity / ETFs listed outside India | > 24 months | 12.5% | Section 112 (Section 112A not applicable) |
Conclusion
The capital gains taxation regime for securities in India has evolved to distinguish sharply between equity-oriented investments and other market-linked instruments. While listed domestic equity and equity mutual funds continue to enjoy concessional long-term tax rates, debt-oriented and international funds face uniform slab-rate taxation under Section 50AA.
For investors, understanding these distinctions is no longer optional—it is central to portfolio structuring, post-tax returns, and long-term wealth planning.
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