Summary of this article
Sebi proposes removing LTCG tax on foreign investors' equity gains
Mutual fund switches after one year may get tax exemption
Experts say tax relief could improve India's appeal to foreign investors
The Securities and Exchange Board of India (Sebi) has recommended removing long-term capital gains (LTCG) tax on foreign investors as it looks to make domestic equities more attractive to overseas capital.
The regulator has also proposed allowing domestic mutual fund investors to switch between schemes without triggering LTCG tax, provided they have held the existing units for more than a year, according to a Reuters report citing two people familiar with the matter.
The recommendations have been made as part of Sebi’s pre-Budget representations to the government ahead of the Union Budget in February. They are not binding, and the final decision rests with the Ministry of Finance, the report said.
The proposals come at a time when Indian equities have struggled to keep pace with emerging market peers. Foreign portfolio investors (FPIs) have sold a record RS 2,90,678 crore worth of domestic stocks this year.
Sebi's recommendations follow several meetings with foreign investors over the past two years, as persistent selling by overseas funds has also put pressure on the rupee. Investors have repeatedly flagged India's tax structure as a concern, said the report.
"The proposals are aimed at reducing the upfront tax burden on foreign investors," one of the sources told Reuters.
Mehul Koradia, chief strategy officer at Mirae Asset Sharekhan, said removing LTCG tax for foreign investors could improve India's appeal at a time when domestic equities are trading at reasonable valuations.
"If this happens, Indian markets may become more appealing to foreign investors as it will reduce the cost of investment for foreign investors. With Indian markets at reasonable valuations, scrapping LTCG for foreign investors can stop the outflow of funds and bring more foreign investment into India," Koradia said.
Sebi Seeks To Improve India's Appeal For Foreign Investors
Currently, foreign investors pay LTCG tax of 12.5 per cent on gains from securities held for more than a year. Short-term capital gains (STCG) are taxed at 20 per cent. These levies are over and above securities transaction tax (STT) on trades and withholding tax on dividends.
Sebi has previously flagged that transaction costs associated with equity investments in India are among the highest across markets.
Akshat Garg, head of research and product at Choice Wealth, said foreign investors account for currency depreciation, the 12.5 per cent LTCG tax and STT while assessing their returns from Indian equities. At the same time, US Treasury yields have remained close to 5 per cent, making dollar-denominated investments more attractive.
"With a 4-5 per cent annual currency drag, a 5 per cent dollar risk-free rate and a 12.5 per cent capital gains tax, Indian equities need to compound at roughly 15 per cent in rupee terms before a dollar investor is meaningfully better off than simply holding a Treasury," Garg said.
He said tax reform was one of the few policy levers available to the government to improve foreign investors' post-tax returns, as it cannot control the dollar, US Treasury yields or crude oil prices. However, he cautioned that removing LTCG tax alone would not be enough.
"India remains among the very few markets levying a transaction tax on turnover and a capital gains tax on profit. An investor pays STT whether or not money is made. The cost of investing has to be examined in full, not in part," Garg said.
He added that tax reforms could lower the cost of investing, but sustained foreign inflows would depend on earnings growth and currency stability.
Domestic Mutual Fund Investors May Also Get Tax Relief
Sebi has also proposed a change in the taxation of domestic mutual fund investments to encourage investors to remain invested in equity schemes.
Under the proposal, as mentioned in the Reuters report, switching from one mutual fund scheme to another would not be treated as a taxable sale if the investor has held the units for more than a year, the two sources told Reuters.
At present, switching between mutual fund schemes is treated as a redemption from the existing scheme and a fresh investment in the new scheme. This can trigger capital gains tax depending on the holding period and the nature of the scheme.
The proposal could reduce the tax burden on investors looking to move their money between schemes without withdrawing it from the mutual fund industry.
