Tax Cut: A Capital Comeback?

By Apurva

Exploring the Impact of Tax relief recommended by SEBI, effect of foreign capital outflows and the factors shaping India’s investment attractiveness .India has experienced some of the highest levels of growth of any major economy globally. This has led to an increase in the number of investors wishing to invest in India due to the increasing businesses and increasing domestic consumption. However, in recent times the stock market has seen a negative trend with foreign investors withdrawing from the Indian market.

Source: INSIGHTSIAS

In order to attract foreign investors to invest in Indian equities the Securities and Exchange Board of India (SEBI) have recommended removing LTCG tax on foreign equity investments. This has brought attention to India’s tax system. To fully understand how this can affect foreign investment in India, it is important to know what LTCG tax is.

Whenever you sell an investment and make a profit, this profit is called a capital gain. Tax will be applied to this profit depending on how long you have held the investment. As long as your investment is in eligible listed equities in India for over 12 months you will generally be liable for long term capital gain tax. Under the current regime, eligible long term capital gains will be taxed at 12.5%.This will reduce the amount of profit the investor will make from their investment. As investors always compare the returns they can get from different countries, tax can play a major role.

Reasons behind Foreign Investors Withdrawal

A large portion of the reason that foreign investors are withdrawing from India is due to poor performance of the market compared to other emerging markets. The Nifty 50 has dropped by 4.8% over the last 2 years whilst the MSCI Emerging Markets Index has increased by around 40%. This has caused investors to turn elsewhere. Currency devaluation is also a concern. Profit from the Indian stock market will not necessarily translate into profit in the foreign investors home currency. There is also competition from the rest of the globe. Investors can easily invest in a range of markets. As a result, capital will flow to opportunities where there is higher potential returns. Increased US Treasury yields, technology and artificial intelligence stocks becoming increasingly popular in markets like the US, Taiwan & South Korea and high valuations on Indian stocks have caused investors to move away. India isn’t competing with other emerging markets, but also the rest of the globe.

  Source: Tradingview

Impact of LTGC Tax on Foreign Investment

A large portion of the issue is that investors can compare returns between two markets. Removing LTCG tax will therefore have an impact.Under the current regime, eligible long-term gains (those held for over 12 months in listed equities) will generally be taxed at 12.5%. If an investor makes a taxable long term capital gain of 10 lakhs, then they will be liable to pay ₹1.25 Lakh tax (plus any additional taxes). This means they are losing out on a portion of their profit to pay the tax.

This is where the competitiveness of India comes into play. Countries such as Singapore and Hong Kong generally do not charge capital gains tax on the sale of ordinary shares. Although some profits on trading may be liable to be taxed as business income. This could be another reason investors are rethinking their investment.Whilst removing LTCG tax may not resolve all issues for foreign investors withdrawing, it will remove one extra cost.

India have removed LTCG tax before. In 2004 the government removed LTCG tax on eligible listed equity transactions and replaced it with STT. However, in 2018 LTCG tax was reintroduced. This time at a rate of 10% on eligible gains above ₹1 Lakh per year. In 2024 this was increased to 12.5% and the exempt amount increased to ₹1.25 Lakh for eligible taxpayers.This shows that the way India taxes equities can alter. The government had to find a balance between giving incentives in the market and earning revenue. This is where we are now seeing the debate once again.

Benefits and Drawbacks

Removing LTCG tax can have many benefits. It will improve the after-tax returns for foreign investors. It will also make Indian equities more competitive. With more foreign investors, this can boost trade, liquidity and positive sentiment.

  Source: Kotak Neo

There can also be drawbacks of this reform. The most obvious is the reduction in revenue the government will receive. Capital gains tax helps contribute to the government. This helps provide public welfare services and infrastructure. In FY2024-25 the total LTCG tax collected was approximately ₹1.29 Lakh Crore (2026 response from parliament). This includes all LTCG tax from eligible categories, not just foreign equity investors. When considering removing LTCG tax, the impact should be carefully considered. Another issue is unfairness. If foreign investors are getting an exemption but domestic retail investors are still paying LTCG tax, questions may be raised. There is also no guarantee that foreign investors will return. If stocks remain expensive or company earnings are disappointing then investors may still not want to invest in India.

Tax Relief may not be Enough

The real issue for India is not just getting foreign investors to return but ensuring they have enough reasons to stay. Whilst improving tax can make India more attractive to investors, it needs to be supported by stronger company earnings, fair valuations, stable currency and consistent economic policies.

The government will also need to consider the impact on revenue. Overall foreign investors will be comparing the overall investment environment. SEBI’s recommendation could help make India’s markets more competitive. However, it cannot solve all the issues. Whilst India may be willing to give foreign investors a tax exit, they will need to give them strong reasons to invest, grow and stay in the market.