SEBI Backs Scrapping Long-Term Capital Gains Tax for Foreign Investors

Tax Proposals Put India’s Equity Appeal and Fund Switching in Focus

SEBI’s pre-budget recommendations seek to ease two different tax frictions, but the government will decide whether either becomes policy.

A bid to reduce the tax burden on overseas capital

The Securities and Exchange Board of India has recommended that the government scrap the long-term capital gains tax on foreign investors’ equity holdings. The proposal is part of the regulator’s pre-budget representations; it is not a policy decision, and the final call rests with the government.

Foreign investors currently pay 12.5% LTCG tax on securities held for more than a year and 20% short-term capital gains tax, alongside securities transaction taxes on trades and withholding taxes on dividends. SEBI has argued that transaction costs for investing in Indian equities are among the highest across jurisdictions. Removing LTCG would address one part of that cost burden, though it would not eliminate the other taxes.

The recommendation follows meetings with foreign investors over two years, as persistent selling has put pressure on the rupee. Foreign investors have sold a record $31 billion in Indian stocks this year, while overseas investments by Indian retail investors have increased as domestic equity returns stagnated.

A tax change could help, but may not reverse the performance gap

The market backdrop helps explain the regulator’s push. India’s Nifty 50 has declined 4.8% over the past two years, while the MSCI emerging market index has gained 40%. A brokerage estimate cited in the report suggests scrapping capital gains tax could lift foreign investors’ returns by 2.3 percentage points. That is a potential improvement in after-tax returns, not a guarantee of renewed inflows.

Tax treatment is one consideration in international investment decisions. The proposal could improve India’s relative attractiveness if adopted, but the market’s performance gap shows why tax relief alone may not determine capital flows. Investors should distinguish the potential benefit of a lower tax burden from the uncertain timing and impact of any government decision.

Mutual fund switches are another focus

SEBI has also recommended that investors be allowed to move from one mutual fund scheme to another without the switch being treated as a taxable sale, provided the units have been held for more than a year. The proposal targets domestic investors rather than foreign portfolio flows, and is intended to make it easier to stay invested in mutual funds when changing schemes.

The case for relief comes amid weak recent returns: average returns from large-cap equity funds were down 1.6% over the period cited. Indian mutual funds manage ₹82.6 trillion in assets, with monthly investment schemes bringing in an average ₹3,000 crore each month. If adopted, the proposed treatment could reduce the tax friction around switching, but it would not change the investment risks or performance of the underlying schemes.

Key Highlights

• SEBI has recommended scrapping LTCG tax for foreign investors; the proposal is non-binding.
• Current taxes include 12.5% LTCG on securities held for more than a year and 20% short-term capital gains tax.
• Foreign investors have sold a record $31 billion in Indian stocks this year.
• SEBI has proposed tax relief for qualifying mutual fund switches after a holding period of more than a year.
• The government’s decision and the timing of any change remain uncertain.

Investor Note: Treat both measures as proposals, not confirmed tax changes. Investors should base decisions on their financial goals, holding periods and risk tolerance rather than anticipating a policy outcome or relying on tax relief alone.