On FM table: Slashing capital gains tax rate, dollar-based taxation for foreign investors

AS INVESTORS grapple with a flat stock market trajectory for more than two years now, discussions within the government in the run-up to Budget 2027-28 include lowering the long-term capital gains tax from 12.5% now for both domestic and foreign investors, and letting foreign investors pay this tax on capital gains made in dollar terms as opposed to in rupee terms, to boost market sentiments.

Officials say the urgency to act fast is due to two key concerns. One, zero returns or losses in stock markets over the last two years come on top of poor wage growth, and this is a big sentiment dampener. It is felt across a larger spectrum of middle class with surging retail participation in markets now.

Post-Covid, stock market investments witnessed a sharp rise in participation by retail investors (those holding up to Rs 2 lakh in shares) looking to diversify and supplement their regular income streams. According to data sourced from Prime Infobase in March 2020, retail shareholding in NSE-listed companies was 6.58% valued at Rs 7.23 lakh crore; it jumped to 7.66% in June 2024 valued at Rs 33.16 lakh crore and dropped to 7.12% in March 2026 valued at Rs 28.97 lakh crore.

In terms of demat investor accounts with CDSL, they jumped to 19.34 crore in September 2026 from just 2.12 crore in March 2020.

Two, the confidence that domestic mutual fund inflows would, by and large, counter the impact of any large-scale Foreign Portfolio Investor (FPI) outflows, has taken a beating. For almost a decade till 2024, domestic funds had always seen every large FPI exit as a buying opportunity.

Explained

Stock market challenge

For the government, it has been a challenge to explain the robust 7.8 per cent growth rate in April-June this year, especially when stock market indices actually dropped over the last two years, and poor wages growth in the private sector. The Budget may hence explore moves to boost the market.

“We are discussing every option,” a senior government official told The Indian Express, when asked if measures for stock markets include a reduction or removal of capital gains tax.

Global investors see the 12.5 per cent LTCG tax as very high compared with similar levies in other markets. For example, China, Indonesia and Brazil, among others have either nil or very minimal capital gains tax. What also hurts them and compounds their problem is that this tax has to be paid on rupee gains and not on dollar gains (or losses).

Story continues below this ad

Section 72 of the Income-tax Act, 2025 that deals with the ‘mode of computation’ of tax says that the income chargeable under the head “capital gains” shall be computed from the full consideration of a capital asset after deducting transfer expenses, acquisition costs, and improvement costs. Foreign currency conversion benefits are provided to non-residents under 72 (6) of the Act for transferring unlisted Indian company shares or debentures to prevent notional gains caused by rupee depreciation. However, this relief explicitly applies only to non-residents and excludes domestic investors and FPIs.

The lack of an AI play, the feeling of overvalued stocks despite significant correction, and rising interest rates across developed markets are being seen as holding back large scale FPI inflows. In this backdrop, an ostensibly adverse taxation structure is not seen to be helping.

Earlier this year on June 5, the government scrapped the withholding tax as well as long and short-term capital gains tax on foreign investors’ investments in government bonds to attract overseas funds. Before that, foreign investors paid 12.5 per cent tax on long-term capital gains, 30 per cent on short-term capital gains, and around 20 per cent withholding tax on interest income from their government bond holdings.

In its latest research report Ecowrap dated October 12, State Bank of India said the government must seriously look into anchoring hot money flows into equity segment by extending the holding period to say 2-3 years and abolishing the long-term capital gains tax for equity.

Story continues below this ad

Earlier this month, Finance Minister Nirmala Sitharaman had said the debate on LTCG tax is “healthy” and she is “keen” to hear about it. At the Bloomberg New Economy, she also said that both domestic and foreign investors ask and comment about the Long-LTCG tax and the Securities Transaction Tax (STT). The debate on “tax in the market” and the tax treatment for all asset classes “has been a very well discussed topic”, she had said.

India’s recurring episodes of capital outflow invite a broader examination of how convincingly the country is positioning itself for the next wave of global investment, Soumya Kanti Ghosh, Group Chief Economic Adviser, State Bank of India said in the SBI Ecowrap. “Artificial intelligence is increasingly shaping expectations of productivity, profitability and technological leadership. Certainty in vision and policy is the need of hour to attract capital in this area as it is the next engine of growth. As competition for AI-linked capital intensifies, regulatory predictability will increasingly matter alongside computing capacity, reliable power and skilled labour,” the report said.