India's stock market regulator has urged the government to remove the long-term capital gains tax charged to foreign investors, according to a report published on Monday, in a move that would mark one of the most significant changes to the taxation of overseas investment in Indian shares in recent years.
The Securities and Exchange Board of India has put the proposal forward as part of its representations ahead of the annual federal budget, which is due to be presented in February, and has also suggested relief for domestic mutual fund investors who switch between schemes.
The recommendations were reported by Reuters, citing two people with direct knowledge of the matter. The sources spoke on condition of anonymity because the proposals are part of private pre-budget representations that have not previously been made public. According to the report, emails sent to the regulator and to the federal finance ministry seeking comment went unanswered, which means the proposals have not yet been confirmed publicly by either institution.
What makes the reported move important is that it is not a binding decision. The regulator can recommend, but the final choice rests with the government, and any change would normally be announced in the budget or through a subsequent tax notification. That distinction matters for investors trying to read the signal.
A recommendation from the market regulator carries weight because it reflects sustained feedback from market participants, but it does not by itself alter the tax law. Until the government acts, the existing tax structure remains in place.
Under the current framework, foreign investors pay long-term capital gains tax of 12.5 per cent on securities held for more than a year, and short-term capital gains tax of 20 per cent on shorter holdings. Those charges sit alongside the securities transaction tax on trades and withholding taxes on dividends.
The regulator has previously argued that the total transaction costs associated with investing in Indian equities are among the highest across major jurisdictions, and the new proposals appear to be aimed directly at reducing that upfront burden.
The timing of the proposal is closely tied to a difficult period for Indian equities. India's benchmark Nifty 50 index has fallen 4.8 per cent over the past two years, while the MSCI emerging market index has risen 40 per cent over the same period. Foreign investors have sold a record 31 billion dollars worth of Indian stocks this year, and overseas investment by retail investors has increased as domestic returns have stagnated.
The regulator's reported recommendations follow scores of meetings with foreign investors over the past two years, during which selling persisted and pressure built on the Indian currency.
One consistent message from those meetings, according to the sources, has been the need to change how India taxes foreign investors. For a large global fund, tax is not a minor detail at the margin. It affects the net return on every trade, the attractiveness of holding a position through a volatile period, and the comparison with other emerging markets where the tax treatment may be simpler or lighter.
A fund deciding between India, Brazil, Indonesia or another large emerging market will weigh expected returns after tax, not just headline index performance, and a high tax wedge can tip that decision.
Brokerage firms cited in the reporting have tried to quantify the possible effect. Jefferies said in a note earlier in the week that any reduction in capital gains taxes could make the Indian market more attractive to foreign investors and support portfolio inflows. IIFL estimated that scrapping the capital gains tax could lift foreign investors' returns by 2.3 percentage points.
Those estimates are not guarantees, and they depend on how a final policy is designed, including whether it applies to all foreign portfolio investors, whether it is limited to long-term holdings, and whether other charges remain unchanged. Even so, they illustrate why the proposal has drawn attention: a change of that size could alter the arithmetic for investors who have been net sellers for much of the year.
The second part of the proposal is aimed at domestic savers, and it may prove just as consequential for ordinary households. The regulator has reportedly suggested that domestic mutual fund investors should be exempt from long-term capital gains tax when they sell existing holdings in order to invest in new ones. More specifically, switching from one mutual fund scheme to another should not be treated as a taxable sale if the units have been held for more than a year.
The aim, according to the report, is to encourage investors to stay invested in domestic mutual funds rather than being discouraged from rebalancing their portfolios by a tax charge at the point of switching.
That point matters because mutual funds have become a common way for Indian households to save for the long term. Indian mutual funds hold 82.6 trillion rupees in assets under management, equivalent to about 870.8 billion dollars, with an average of 30 billion rupees flowing in each month through systematic investment plans. Yet returns from diversified domestic equity funds have also stagnated over the recent period.
Average returns from funds investing in large-cap stocks are down 1.6 per cent, according to data from fund research firm Morningstar cited in the report. If investors feel locked into a scheme because moving would trigger tax, they may hold a portfolio that no longer suits their goals, or they may withdraw altogether. Removing the tax friction on switches could therefore change behaviour without requiring investors to leave the mutual fund system.
The broader debate around the proposal will turn on revenue, fairness and competitiveness. Any reduction in capital gains tax means the government forgoes revenue it would otherwise collect, at a time when it must balance spending demands with fiscal discipline. Supporters of the change argue that the loss could be offset, at least in part, by stronger inflows, deeper markets and higher activity, which would generate revenue through other channels and support economic growth.
Critics may argue that tax relief for investors, particularly foreign funds, should be weighed against the needs of other taxpayers and against the principle that gains from financial assets should be taxed like other forms of income. Those arguments will now play out in the run-up to the budget, as industry bodies, economists and policymakers respond to the reported recommendations.
There is also a question of design. A blanket removal of long-term capital gains tax for foreign investors would be the most sweeping option, but the government could also choose a narrower route, such as a reduced rate, a longer holding threshold, or relief limited to certain categories of investors.
Similarly, for mutual funds, the details will matter: which switches qualify, how the holding period is calculated, and how the change interacts with existing rules on short-term gains. Until a formal proposal is published, market participants will be parsing every signal for clues about which version the government might favour.
For now, the most reliable reading of the report is that the regulator has made a clear case for reform, and that the government will have to decide whether to accept it. The fact that the recommendations come months before the budget suggests that they are intended to shape the debate early, giving the finance ministry time to assess the fiscal cost and the market impact.
It also suggests that the regulator sees the current tax structure as a structural drag on India's ability to attract and retain foreign capital, rather than a temporary irritant caused by a single year of selling.
If the government does move in the direction suggested, the effects would be felt well beyond trading floors. Stronger foreign inflows can support the rupee, lower the cost of capital for Indian companies, and deepen liquidity in the market, which in turn can affect borrowing costs and investment decisions across the economy. For domestic savers, a simpler and less punitive treatment of mutual fund switches could make long-term investing more flexible and less intimidating.
Neither outcome is guaranteed, and both depend on the final policy, but the reported proposals have at least put the question firmly on the agenda.
The coming weeks will therefore be watched closely. Investors will look for any official response from the regulator or the finance ministry, for comments from market participants, and for signs in the pre-budget consultation process that the proposal is gaining traction.
Until then, the report stands as a significant indication of the direction in which India's market regulator would like tax policy to move: towards lower friction, greater competitiveness, and a tax system that does not discourage the very investment the market is trying to attract.
(Reporting based on Reuters and The Economic Times.)