How are index funds taxed?

Index funds are a popular investment choice for those seeking low costs and broad market exposure. But their tax treatment depends entirely on what the fund is tracking—equity, debt or international indices. While all three are passive in nature, the tax rules are different. Equity index funds: Preferential tax treatment Index funds that invest predominantly in Indian stocks—such as the Nifty 50, Sensex or Nifty Next 50—qualify as equity-oriented mutual funds. This classification brings two advantages: A concessional tax rate and a shorter holding period to qualify for long-term capital gains. If held for more than one year, gains qualify as long-term capital gains (LTCG). LTCG up to Rs 1.25 lakh in a financial year is tax-free. Gains above that threshold are taxed at 12.5 per cent. If redeemed within a year, short-term capital gains (STCG) are taxed at a flat 20 per cent. Sectoral or thematic index funds, too, fall under the equity umbrella. So, whether you’re investing in a Nifty Bank, Nifty IT or Nifty PSU index fund, the same tax rules apply. Debt index funds: Taxed like income Debt index funds track fixed-income benchmarks such as the Crisil Composite Bond Fund Index or government securities indices. However, they do not qualify as equity-oriented funds, and hence, receive no special tax treatm

This article was originally published on June 17, 2025.