SEBI backs foreign capital gains tax removal to revive India equity inflows

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SEBI supports tax removal for equity inflows

Highlights

SEBI has recommended scrapping the 12.5% long-term capital gains tax for foreign investors and relaxing rules for domestic mutual fund switches in pre-budget proposals.
Foreign investors have sold a record $31 billion of Indian stocks in 2024, pressuring both the equity market and the rupee amid high tax and transaction costs.
Jefferies and IIFL estimate that removing capital gains taxes could increase foreign investor returns by 2.3 percentage points and boost capital inflows to Indian equities.

Pre-budget tax proposals for foreign and fund investors

As first reported by Reuters, the Securities and Exchange Board of India has recommended that the government scrap long-term capital gains tax for foreign investors, according to two sources with direct knowledge of the matter. The regulator has also proposed relief for domestic mutual fund investors by exempting certain long-term switches from one scheme to another when the proceeds are reinvested.

The recommendations are part of pre-budget representations submitted months before the annual federal budget in February, and they are not binding on the government. The sources said the regulator has held numerous meetings with foreign investors over the past two years, during which tax treatment repeatedly emerged as a key concern.

Foreign investors currently pay a 12.5% long-term capital gains tax on securities held for more than a year and a 20% short-term capital gains tax, in addition to securities transaction taxes on trades and withholding taxes on dividends. One source said the proposals are intended to reduce the upfront tax burden on foreign investors.

Pressure on market competitiveness and capital flows

India's equity market has trailed other emerging markets over the past two years, while foreign investors have sold a record $31 billion of Indian stocks this year. Persistent selling has also added pressure on the Indian currency, even as overseas investing by Indian retail investors has increased amid stagnant domestic returns.

SEBI has already said that transaction costs for investing in Indian equities are among the highest across jurisdictions. Jefferies said earlier this week that any reduction in capital gains taxes could make the market more attractive to foreign investors and support portfolio inflows, while IIFL estimates that removing the tax could increase foreign investor returns by 2.3 percentage points.

On the domestic side, the proposal is also aimed at keeping savers invested in mutual funds for longer. Indian mutual funds manage 82.6 trillion rupees, or about $870.80 billion, in assets, with average monthly inflows of 30 billion rupees through regular investment plans.

In our earlier article on the Reserve Bank of India’s rupee-defence operations, we detailed how the RBI deployed an estimated $75–$80 billion from its special foreign-exchange measures to counter currency pressure. We noted that persistent foreign equity outflows, higher oil prices and rising U.S. yields were weighing on the rupee, prompting stepped-up intervention and additional steps to curb dollar demand as usable reserves drew more scrutiny.

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