Tax relief for foreign investors? India’s market regulator wants to scrap LTCG, says report

India’s market regulator has proposed scrapping the long-term capital gains (LTCG) tax on foreign investors as it looks to make domestic equities more attractive and reverse a sustained outflow of overseas money from the country’s stock markets, Reuters reported on Monday, citing sources familiar with the matter.

The Securities and Exchange Board of India (SEBI) has recommended that the government remove the tax as part of its pre-Budget proposals ahead of the Union Budget in February 2027. The recommendations are not binding, and the final decision rests with the government, the report said.

According to the report, SEBI has also proposed tax relief for domestic mutual fund investors. It wants investors to be exempt from LTCG tax when they switch from one mutual fund scheme to another, provided they have held the existing units for more than a year.

The proposals come as Indian equities struggle to keep pace with other emerging markets. The Nifty 50 has declined 4.8 per cent over the past two years, while the MSCI emerging markets index has gained 40 per cent over the same period.

Foreign investors have sold a record $31 billion worth of Indian stocks this year, while overseas investments by domestic retail investors have increased amid subdued returns from local equities.

Why SEBI wants to scrap LTCG tax for foreign investors

SEBI’s proposals follow several rounds of discussions with foreign investors over the past two years as overseas selling continued to weigh on Indian markets and put pressure on the rupee.

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One of the recurring concerns raised by investors was India’s tax structure, the sources told Reuters.

“The proposals are aimed at reducing the upfront tax burden on foreign investors,” the report said.

Foreign investors currently pay a 12.5 per cent LTCG tax on securities held for more than a year. Short-term capital gains are taxed at 20 per cent. These levies are in addition to securities transaction taxes on trades and withholding taxes on dividends.

SEBI has previously flagged that the transaction costs associated with investing in Indian equities are among the highest across markets.

Brokerage firm Jefferies said in a note earlier this week that reducing capital gains taxes could improve the attractiveness of Indian equities and support portfolio inflows.

IIFL estimates that scrapping the capital gains tax could increase foreign investors’ returns by 2.3 percentage points.

What SEBI has proposed for mutual fund investors

The regulator’s recommendations also seek to ease the tax burden on domestic mutual fund investors and encourage them to remain invested in Indian equities.

Under the proposal, switching investments from one mutual fund scheme to another would not be treated as a taxable sale if the units being switched have been held for more than a year.

Currently, switching between mutual fund schemes can trigger capital gains tax, even when investors remain within the mutual fund market.

The proposal seeks to remove this tax friction and give investors greater flexibility to move their money between schemes without facing an immediate tax liability.

The issue is significant given the size of India’s mutual fund industry. Domestic mutual funds manage assets worth Rs 82.6 trillion (around $870.8 billion), with monthly investment schemes bringing in an average of Rs 30 billion.

Returns from diversified domestic equity mutual funds have also remained subdued. According to Morningstar data cited by Reuters, average returns from large-cap equity funds have declined 1.6 per cent over the period.

Will the government accept SEBI’s proposals?

SEBI’s recommendations will form part of its pre-Budget representations to the government. They do not amount to an official policy decision, and the finance ministry will have the final say on any changes to capital gains taxation.

The proposals could become part of the broader debate over how India can attract foreign portfolio investments while encouraging domestic households to continue investing in local equities.