Why Are ETFs and Non-ETF Mutual Funds Taxed Differently in India?

Introduction

Investors often notice that an Exchange Traded Fund (ETF) and a regular mutual fund investing in broadly similar assets can have different capital-gains holding periods.

For example, a Gold ETF may qualify as a long-term capital asset after 12 months, while a regular Gold Fund or Gold Fund of Fund may generally require more than 24 months.

At first glance, this may appear to mean that the Income-tax law creates separate tax rules specifically for ETFs and non-ETFs.

That is not technically correct.

The Income-tax law does not contain a blanket rule stating that “ETF = one tax treatment” and “non-ETF = another tax treatment.” The difference mainly arises because ETFs are generally listed and traded on a recognised stock exchange, whereas regular mutual fund units are usually not exchange-listed.

The law also contains separate rules for equity-oriented funds and Specified Mutual Funds, especially debt-oriented funds.

What is an ETF?

An Exchange Traded Fund, or ETF, is a pooled investment product that may track an index, commodity, bonds or another basket of assets.

Unlike a conventional mutual fund, ETF units are generally bought and sold on a stock exchange during market hours, similar to shares.

This listing is important for income-tax purposes because the capital-gains provisions specifically recognise listed securities.

A regular open-ended mutual fund, on the other hand, is generally purchased from and redeemed with the mutual fund at the applicable Net Asset Value (NAV), rather than traded between investors on a stock exchange.

The Real Reason ETFs and Non-ETFs Can Have Different Tax Treatment

The capital-gains rules were rationalised through the Finance (No. 2) Act, 2024. Broadly, the law now follows two main holding-period categories:

The Income-tax Act, 2025 continues this structure. Under section 2(101), the normal holding period is 24 months, but a 12-month period applies to specified assets such as securities listed on a recognised stock exchange in India and units of an equity-oriented fund.

Therefore, in broad terms:

• ETF → generally listed → 12-month holding-period rule may apply
• Regular non-ETF mutual fund → generally unlisted → 24-month holding-period rule may apply

However, this is only the starting point. Special provisions may override this general distinction.

ETF vs Non-ETF Taxation: Correct Classification

Tax rates mentioned above are before applicable surcharge and Health and Education Cess and are subject to the specific statutory conditions applicable to the investment.

Equity ETFs and Regular Equity Mutual Funds Are Generally Not Taxed Differently

This is one of the most important exceptions to the common belief that ETFs and non-ETFs always have different tax treatment.

If an equity ETF satisfies the statutory definition of an equity-oriented fund, and a regular equity mutual fund also satisfies that definition, both broadly fall under the same special capital-gains regime.

Under the Income-tax Act, 2025, short-term capital gains from qualifying equity shares, units of equity-oriented funds and units of business trusts are generally taxed at 20%, subject to the prescribed Securities Transaction Tax conditions.

Long-term capital gains from qualifying equity-oriented assets are generally taxed at 12.5% on gains exceeding the statutory exemption threshold of ₹1,25,000, subject to the applicable conditions.

Therefore, being an ETF does not by itself result in preferential equity taxation.

Why Gold ETFs and Gold Funds Can Be Taxed Differently

Gold provides one of the clearest examples of why investors encounter different tax treatment between ETFs and conventional mutual funds.

Consider:

• Investment A: Gold ETF listed on NSE or BSE
• Investment B: Regular Gold Fund or Gold Fund of Fund that is not listed

Neither investment is ordinarily treated as an equity-oriented fund.

However, the Gold ETF is listed on a recognised stock exchange. Therefore, the 12-month holding-period rule applicable to listed securities can apply.

The regular Gold Fund is generally not exchange-listed. Therefore, the normal 24-month holding-period rule can apply.

This is why two investment products providing exposure to the same underlying asset may still have different capital-gains classification.

The difference arises from the legal nature and listing status of the investment unit, rather than merely from the fact that both invest in gold.

Example: Gold ETF vs Gold Fund

Assume an investor purchases each investment for ₹5,00,000 on 1 July 2026 and sells it on 1 October 2027 for ₹6,20,000.

Capital gain:

₹6,20,000 − ₹5,00,000 = ₹1,20,000

The holding period is approximately 15 months.

Gold ETF

Since the ETF has been held for more than 12 months, it may qualify as a long-term capital asset, assuming the listing and other statutory conditions are satisfied and no special provision applies.

LTCG tax, before cess and surcharge:

₹1,20,000 × 12.5% = ₹15,000

Non-Listed Gold Fund

A 15-month holding period does not exceed the general 24-month threshold applicable to an unlisted unit. The gain would therefore generally remain short-term and would be taxed at the applicable rates applicable to the taxpayer.

Debt ETFs Are an Important Exception

It would be incorrect to conclude that every listed ETF automatically qualifies as a long-term capital asset after 12 months.

A separate special rule applies to a Specified Mutual Fund.

From AY 2026-27 onwards, the definition broadly covers a mutual fund that invests more than 65% of its total proceeds in debt and money-market instruments, or a fund investing at least 65% of its proceeds in units of such a fund.

Under the Income-tax Act, 2025, the special rule is contained in section 76.

Where the provision applies to qualifying units acquired on or after 1 April 2023, the resulting gain is treated as short-term capital gain.

Therefore, if a debt ETF satisfies the Specified Mutual Fund definition, the fact that it is listed on a stock exchange does not automatically give the investor long-term capital-gains treatment after 12 months.

The special Specified Mutual Fund provision overrides the ordinary holding-period rule.

What Changed From 1 April 2026?

This change is particularly relevant for Gold ETFs, international funds and other non-equity mutual fund products.

Earlier, section 50AA of the Income-tax Act, 1961 used a broader definition of Specified Mutual Fund that broadly captured schemes with not more than 35% investment in domestic equity.

The Finance (No. 2) Act, 2024 amended this definition with effect from 1 April 2026.

The revised definition primarily focuses on funds investing predominantly in debt and money-market instruments.

As a result, certain non-equity products such as Gold ETFs and some international funds are no longer automatically covered by the Specified Mutual Fund rule merely because they do not hold sufficient domestic equity.

Their ordinary listed or unlisted holding-period classification therefore becomes more important.

Income-tax Act, 1961 vs Income-tax Act, 2025

The Income-tax Act, 2025 applies from 1 April 2026.

Income earned during FY 2025-26 continues to be governed by the Income-tax Act, 1961 and is assessed in AY 2026-27. Income arising from 1 April 2026 onwards is governed by the Income-tax Act, 2025 under the tax-year system.

Common Misunderstanding: “ETFs Have Lower Tax”

It is misleading to say that ETFs automatically receive better tax treatment.

An ETF may have a shorter holding period because it is listed, but the final tax treatment depends on several factors, including:

• Whether the ETF qualifies as an equity-oriented fund
• Whether it is covered under the Specified Mutual Fund rules
• Whether it is listed on a recognised stock exchange in India
• How long the units have been held
• Whether Securities Transaction Tax conditions apply
• The date of acquisition of the units
• The tax year or financial year in which the gain arises

Therefore, investors should first identify the type of fund and its legal classification before determining the applicable holding period and tax rate.

Practical Takeaway

The easiest way to understand the ETF and non-ETF distinction is:

The Income-tax law primarily distinguishes between listed and unlisted assets, equity-oriented funds and specified debt mutual funds — not merely between “ETF” and “non-ETF”.

For non-equity investments such as Gold or Silver funds, listing can make a significant difference because a listed ETF may generally become a long-term capital asset after 12 months, while a comparable unlisted fund may require more than 24 months.

For equity-oriented schemes, however, a qualifying ETF and a conventional equity mutual fund generally receive similar capital-gains treatment.

For debt-oriented schemes covered under the Specified Mutual Fund provisions, the special rule can override the normal listing benefit and deem the gain to be short-term.

Conclusion

ETFs and non-ETF mutual funds may appear to be taxed separately because their legal and trading structures are different.

ETFs are generally listed and exchange-traded, which can bring them within the shorter 12-month holding-period category applicable to listed securities. Regular mutual funds are usually unlisted and may therefore fall under the general 24-month holding-period rule.

However, this is not a universal rule. Equity-oriented funds have their own special capital-gains provisions, while debt-heavy Specified Mutual Funds are subject to a separate provision that can deem gains to be short-term irrespective of the ordinary holding period.

Taxpayers should therefore not determine capital-gains taxation merely from the words “ETF” or “mutual fund”. The underlying asset allocation, listing status, statutory classification, acquisition date and applicable tax year must all be examined.

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