Introduction
Savvy investors who wish to create income through exchange-traded funds (ETFs) often utilise Liquid ETFs and Liquid BeES. These investment options offer potential dividends. If you wish to generate consistent profits from them, you need to be acquainted with the taxation implications that affect these earnings. To learn more, let's take a quick look at what ETFs, liquid ETFs, and liquid BeES are.
What are Exchange-Traded Funds (ETFs)?
As the name suggests, ETFs are a collection of securities or indices that are traded just like you would do with individual stocks on an exchange. They combine the diversity of mutual funds and the ease of equities, as they are traded throughout the trading session. A liquid ETF is essentially the same thing.
Start Investing with Free Expert Advice!
Liquid BeES is a type of ETF that work in the same way that shares do. Both of these share the same purpose, i.e., to reduce the risk factor and improve profit margins by diversifying a portfolio. They also ensure liquidity and maintain security.
What are the taxation rules on Liquid ETFs and Liquid BeES?
In India, the taxation of dividends on Liquid ETFs and Liquid BeES is dictated by the Income Tax Act of 1961 and the rules implemented by the Central Board of Direct Taxes (CBDT). Let us take a look at the various taxes that can be levied on these dividends:
- Dividend Distribution Tax (DDT): Before April 1, 2020, both Liquid ETFs and Liquid BeES were subject to Dividend Distribution Tax (DDT). This meant that the mutual fund house was obligated to pay the DDT. Now this responsibility has shifted to the individuals who receive the dividends.
- Individual taxation: When individuals receive dividends from Liquid ETFs and Liquid BeES, they are considered 'Income from Other Sources'. The dividends are added to the individual’s total income and are taxed based on the applicable income tax slab rates.
- Tax Deduction at Source (TDS): TDS applies to both liquid ETFs and liquid BeES at a rate of 10 per cent in case the dividend income goes over Rs. 5,000 within a financial year. In case your total income is under the taxable threshold, you can submit Form 15G/15H to the mutual fund. This is a self-declaration that will help you steer clear of TDS.
- Taxation on Non-PAN holders: In case the investors do not provide their Permanent Account Number (PAN) to the fund house, they will be subjected to a higher TDS deduction rate.
- Capital Gains Tax: If you want to sell your liquid ETFs and liquid BeES for a profit, you will be liable to pay a capital gains tax. If your holding period is less than three years, it is considered being a short-term capital gain. Herein, you will be taxed at a rate of 15 per cent. However, if your holding period is over three years, it will be treated as a long-term capital gain. Tax at a flat rate of 10 per cent will be applicable.
In case of long-term capital gain, you will not be taxed at all for your first Rs. 1,00,000.
To understand how taxation works, let us take a look at a hypothetical scenario. Let us say you buy 100 units at Rs. 100 per unit. You receive a dividend of 10 units and you hold it for a year. The tax levied on these dividends will depend on your income tax slab rate and can be calculated simply as:
Number of Units * Cost per Unit * Slab Rate
This will come out to be - 35 * Rs. 100 * Slab Rate
Herein, your acquisition cost shall be the raw value of the dividend units, which is 35 * Rs. 100. When you decide to sell them, the profits that you earn will be taxable depending on the duration of the holding. As discussed above, it could be a short-term or long-term capital gain.
Closing Thoughts
You, as an investor, need to be aware of the different taxes applicable to your investments. Having a thorough knowledge will not only help you make smart investments but also assist with saving up on taxes where possible.
Related Articles: Using futures as a form of Margin Trading in Stocks | The importance of operating margins for a company