Has budget ‘24 put gold ETFs at an advantage over gold mutual funds?

India is one of the largest consumers of physical gold, ranging from jewellery, bars and coins.

The 2024 union budget has freed gold funds from the higher taxation regime of debt mutual funds, which has made this category attractive to investors. At the same time, while streamlining capital gains taxes on financial assets into two periods — 12 and 24 months — the budget may have created a disparity between gold exchange-traded funds (ETFs) and gold mutual funds.

Gold ETFs are passively managed mutual fund schemes investing in standard gold bullion of 99.5 percent purity. They track the domestic price of gold closely. Gold mutual funds, on the other hand, are funds of funds that invest in gold ETFs.

What has changed in the budget?

With the amendments to the Finance Act, 2023, gold funds / ETFs, like debt funds under Section 50 AA, were taxed at the slab rate without any provision of short or long-term holding.

However, budget 2024 has introduced a new definition of `Specified Mutual Funds' under Section 50 AA, which includes funds investing 65 percent or more in debt-based securities. This means that gold funds would not be treated on par with debt funds from a taxation perspective.

The budget, which was announced earlier this week, also simplified the holding period into two categories — one  year for listed securities, and two years for all other assets. Earlier, there were three holding periods pertaining to long-term capital assets.

Taxation of debt funds

Per the budget provisions, there will now be three categories of mutual funds. One, investing more than 65 percent of assets in equities. Here, the taxation would be 12.5 percent on long-term capital gains (LTCG) when the holding period is at least a year, and if held for less than that, short term capital gains (STCG) would be taxed at 20 percent.

Also read | No benefit in buying gold from Dubai after customs duty cut, says Popley Jewellers' Rajiv Popley

The second category is funds investing more than 65 percent in fixed income, where irrespective of the holding period, gains are taxed at the slab rates.

In the third category, where we have gold funds of funds, the long-term holding period is two years, without any indexation.

Thus, due to the government’s provisions on listed and unlisted assets, there's now a difference in what's considered 'long term' for gold (mutual) funds of funds and gold ETFs.

“Since gold ETFs are products listed on exchanges, investors can now avail of LTCG if the asset is held for 12 months. However, since gold funds of funds are not listed, investors can claim LTCG if they've held the asset for two years. This will be applicable for transactions conducted April 1, 2025, onwards,” said Arun Sundaresan, Head ETF, Nippon Life India Asset Management.

In a nutshell, for gold ETFs, the LTCG period would be 12 months, which would be taxed at 12.5 percent without indexation, while the STCG would be taxed at the applicable slab rate.

For gold funds of funds, the LTCG period would be 24 months with a taxation of 12.5 percent, and STCG will be taxed  at the slab rate.

ETFs or gold funds?

With the LTCG period on gold ETFs coming down to 12 months against 24 months for gold funds, does the former become more appealing?

“Highly unlikely,” says Suresh Sadagopan, a SEBI-registered investment advisor and Principal Officer at Ladder7 Wealth Planners.

“For regular investors, the suggestion is not to trade in gold ETFs. Gold also has a long-term cycle, where taking advantage of it in the short term seems difficult. In some cases, let’s say, when someone has an emergency and needs to cash out, in that limited situation, gold ETFs might have an advantage,” said Sadagopan.

Also read | The Union Budget does not alter the investment case for gold

According to Chirag Mehata, Chief Investment Officer at Quantum AMC,  gold ETFs might have an advantage from a taxation perspective. “However, we have seen people allocating and accumulating gold over a long timeframe, where the tax rate is 12.5 percent for both types of assets,” he explained.

Also, keep in mind that there are charges involved in the case of  listed financial assets, such demat charges and brokerage fees. Also, at times ETFs may be trading at a premium, which might impact your overall returns if you enter the market at that point.

Confusion over taxation

Some tax experts Moneycontrol spoke to had a different stand on how gold funds and gold ETFs would be taxed.

According to Amit Maheshwari, Tax Partner, AKM Global, a tax and consulting firm, “With the changes proposed in the capital gains regime in budget 2024, financial instruments such as gold mutual funds and gold ETFs are likely to attract more short-term investors as the holding period for them to qualify for LTCG has been reduced from 36 months to 24 months. Though the LTCG tax rate has been marginally increased from 10 to 12.5 percent, this should not be a major concern for investors who are planning short-term investments with a holding period of two-three years.”

Maheshwari further argues that  the 12-month holding period for LTCG is for listed equity assets only. “Gold ETFs are treated as non-equity assets. Hence, the 24-month holding period is applicable,” he said.

Riaz Thingna, Partner, Grant Thornton Bharat, meanwhile, believes that since gold (mutual) funds of funds themselves invest in listed gold ETFs, they will both be treated  on par with equity mutual funds. Hence, the LTCG period will be 12 months for both.