SEBI Proposes Scrapping LTCG Tax for Foreign Portfolio Investors

Markets regulator Securities and Exchange Board of India has recommended that the government eliminate long-term capital gains tax on foreign portfolio investors, Business Standard reported. The market regulator also proposed tax relief for domestic mutual fund unitholders who switch capital between mutual fund schemes, Business Standard noted. The regulatory representations are non-binding recommendations submitted ahead of the annual federal budget in February, with final authority resting with the central government, LiveMint reported. The proposals emerge as foreign portfolio investors have withdrawn a record $31 billion from domestic equities during the year, putting downward pressure on Indian equity indices and the rupee, Economic Times stated.

Current Equity Tax Framework and Cost Structure

Under existing taxation rules, foreign portfolio investors bear an equity tax structure identical to domestic participants, Business Standard reported. Investors currently pay a long-term capital gains tax of 12.5 per cent on eligible holdings maintained for more than one year, alongside short-term capital gains tax of 20 per cent on shorter investments, Business Standard noted. The regulatory body observed that equity trading transaction costs in India rank among the highest across international jurisdictions when combined with securities transaction tax and dividend withholding levies. Brokerage firm IIFL estimates that eliminating long-term capital gains levies could enhance foreign portfolio returns by approximately 2.3 percentage points.

Outflow Pressures and Institutional Sentiment

The regulatory initiative follows multiple consultation sessions conducted with foreign institutional investors over the preceding two years to understand persistent equity outflows, LiveMint reported. According to depository records, overseas funds sold ₹34,843 crore in October after offloading ₹35,861 crore in September, lifting cumulative 2026 equity outflows to ₹2.95 trillion. Although foreign investors briefly turned net buyers between October 26 and October 30 by purchasing around ₹6,300 crore in equities, analysts caution this does not represent a durable trend reversal. Brokerage firm Jefferies noted that lowering long-term capital gains tax could revive portfolio inflows and strengthen the domestic currency, benefiting financial services, energy, and consumer technology sectors.

Domestic Mutual Fund Switching Relief and Market Drivers

For retail participants, the regulator recommended that switching between schemes within a mutual fund house should not constitute a taxable transaction if held over a year, Economic Times reported. The mutual fund switch concession aims to encourage retail investors to remain invested across domestic equity schemes without triggering immediate capital gains tax liabilities. The domestic mutual fund industry manages approximately 82.6 trillion rupees in assets under management, absorbing roughly 30 billion rupees in systematic monthly inflows, Economic Times noted. Market analysts emphasized that while tax rationalization improves post-tax returns, long-term foreign investor allocations will ultimately depend on corporate earnings delivery, valuations, and currency stability.

In February 2018, Union Finance Minister Arun Jaitley proposed to tax long term capital gains exceeding Rs.1 lakh at the rate of 10% without indexation benefits in the General Budget 2018-19, grandfathering gains up to 31st January, 2018, according to Press Information Bureau.

Research compiled by Morningstar indicates that large-cap mutual funds averaged negative returns of 1.6 percent over a two-year span, contrasting with a 4.8 percent decline in the Nifty 50 and a 40 percent rise in the MSCI emerging markets index, according to The Times of India.