SEBI Proposes LTCG Tax Relief for FPIs: Impact on Indian Markets

A Tax Reset Could Improve India’s Appeal to Overseas Investors

SEBI’s recommendations target a cost that foreign investors have repeatedly flagged, but any change rests with the government—and may not be enough to reverse outflows.

A proposal, not an immediate tax change

SEBI’s recommendations are part of its pre-Budget representations and could be considered by the Centre ahead of the Union Budget in February 2027. Until the government acts, the existing tax rules remain in place. The distinction matters: investors should not treat the proposal as a confirmed policy change or assume it will alter near-term portfolio decisions.

Under the current structure, eligible equity gains on listed shares and equity-oriented mutual funds held for more than 12 months are subject to 12.5% LTCG tax above the annual exemption limit of ₹1.25 lakh. Eligible holdings sold within a year are subject to 20% short-term capital gains tax. The LTCG rate and exemption limit were revised in the Union Budget 2024-25, with the changes effective from July 23, 2024.

The case for easing the cost of foreign investment

Overseas investors have raised taxation in discussions with the regulator over the past two years. Earlier, some foreign investors benefited from routing investments through tax-friendly jurisdictions under double-taxation agreements; several such routes were largely closed from April 2019. Capital gains tax now sits alongside securities transaction tax and dividend withholding tax as part of the cost of investing in Indian equities.

Brokerage IIFL estimates that removing capital gains tax could improve foreign investors’ returns by 2.3 percentage points. That could make Indian equities more competitive on an after-tax basis, but it is an estimate of a potential benefit—not a forecast of how much money would return. SEBI has also flagged India’s transaction costs as high compared with other jurisdictions.

Outflows show why the debate has gained urgency

Foreign investors withdrew ₹34,843 crore from Indian equities in October, after pulling out ₹35,861 crore in September, according to depository data. Cumulative outflows in 2026 reached ₹2.95 trillion by the end of October. A late-month return to buying—around ₹6,300 crore from October 26 to 30—was encouraging, but did not establish that flows had turned sustainably positive.

The selling has also reflected elevated crude oil prices, concerns about global interest rates, higher US bond yields, alternative investment opportunities and uncertainty over corporate earnings. Tax relief could improve sentiment and, if foreign buying recovers, potentially support equities and the rupee. But flows are shaped by several factors; a tax change alone would not resolve concerns about valuations, earnings delivery or currency stability.

Fiscal trade-offs and domestic investors

The government would also need to weigh any relief against revenue implications. Jefferies put equity LTCG tax collections at ₹1.3 trillion in FY25, making the potential fiscal cost a significant part of the policy discussion. The proposal for mutual fund investors is narrower: it would allow a tax-free switch between schemes if units have been held for more than a year. That could make portfolio rebalancing easier, though the recommendation is not yet a rule.

A sustained revival in foreign investment would depend on more than tax treatment. Earnings growth, valuations, currency confidence and India’s relative appeal among emerging markets remain central to investment decisions. Financial services, energy and consumer technology were identified by Jefferies as sectors that could benefit if foreign flows recover, but that outcome is not assured.

Key Highlights

• SEBI has recommended scrapping LTCG tax on foreign investors’ equity investments; the Centre has the final say.
• It has also proposed tax-free switches between domestic mutual fund schemes for units held over a year.
• Current eligible equity LTCG is taxed at 12.5% above the ₹1.25 lakh annual exemption limit.
• October FPI equity outflows followed heavy selling in September, despite late-month buying.
• Tax relief may improve post-tax returns, but earnings, valuations and currency stability remain key to foreign flows.

Investor Note: Treat the recommendations as a policy proposal, not a confirmed catalyst. Investors should watch for a government decision and assess any eventual change alongside earnings, valuations and currency trends rather than relying on tax relief alone to signal a durable market recovery.