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 treatment.

• There is no concept of long-term capital gains here.
• All gains—regardless of holding period—are added to your taxable income.
• These are then taxed as per your income slab.

So, whether you hold the fund for six months or three years, the tax treatment remains the same. There is no benefit of indexation or lower tax rates for long-term holding.

That said, these funds still offer some advantages over fixed deposits, such as liquidity, transparency and the fact that tax is incurred only on redemption—unlike FDs, where interest is taxed annually.

International index funds: Hybrid tax treatment

International index funds—those that track benchmarks like the US-based S&P 500 or Nasdaq 100 indices—may invest in global equities, but under Indian tax rules, they are not classified as equity funds.

Instead, they follow a hybrid tax structure:

• If held for less than two years, capital gains are taxed at your income slab rate.
• If held for more than two years, gains are treated as long-term and taxed at a flat 12.5 per cent, without any exemption limit.

This makes them different from both equity and debt funds. You don’t get the Rs 1.25 lakh LTCG exemption that applies to equity funds, nor any benefit of indexation that older debt funds once offered.

The reason lies in regulation: To qualify as equity-oriented for tax purposes, a fund must invest at least 65 per cent in Indian equities. Exposure to international stocks, even if they’re equities, doesn’t count.

What about dividends?

If your index fund pays dividends, the amount is added to your income and taxed as per your slab rate. Also, if your total dividend income from mutual funds exceeds Rs 10,000 in a financial year, the fund house will deduct 10 per cent at source.

Final word

Just because two funds are called ‘index’ funds doesn’t mean they’re taxed the same way. So, understand what your fund invests in—not just what it’s called—before making decisions that have tax consequences.

An investor education and awareness initiative of Nippon India Mutual Fund.

Helpful Information for Mutual Fund Investors: All Mutual Fund investors have to go through a one-time KYC (know your Customer) process. Investors should deal only with registered mutual funds, to be verified on SEBI website under 'Intermediaries/Market Infrastructure Institutions'. For redressal of your complaints, you may please visit www.scores.gov.in. For more info on KYC, change in various details and redressal of complaints, visit mf.nipponindiaim.com/InvestorEducation/what-to-know-when-investing.

Mutual fund investments are subject to market risks, read all scheme related documents carefully.

Also read: How are exchange-traded funds (ETFs) taxed?

This article was originally published on June 17, 2025.