SEBI has recommended removing the 12.5% long-term capital gains tax for foreign portfolio investors following a record $31 billion exit from Indian markets in 2026. While the move aims to boost competitiveness, the final decision rests with the Finance Ministry, which is balancing fiscal revenue needs against the requirement to attract global capital.
The Securities and Exchange Board of India (SEBI) has submitted a formal recommendation to the government proposing the abolition of the 12.5% Long-Term Capital Gains (LTCG) tax specifically for Foreign Portfolio Investors (FPIs). This proposal comes as part of pre-budget deliberations for the 2027-28 fiscal year, aimed at addressing the sharp decline in foreign investment interest in Indian equities.
The push for tax reform follows a challenging year for the Indian stock market, which witnessed approximately $31 billion in net outflows from foreign investors throughout 2026. This significant capital exit has prompted regulators to explore ways to make the Indian market more attractive compared to other emerging economies. By removing the 12.5% tax levy on long-term gains, the proposal seeks to improve the net returns for international institutional investors.
The Fiscal Trade-Off
While the proposal aims to improve market sentiment, the Finance Ministry faces a complex decision. Taxing capital gains provides a substantial revenue stream for the government. Reports suggest that exempting FPIs from this tax could result in a potential revenue impact estimated between ₹40,000 crore and ₹50,000 crore annually. Policymakers must now weigh whether the long-term benefit of increased liquidity and stable capital flows outweighs this immediate loss in tax receipts.
It is important for investors to note that this is currently a non-binding recommendation. The proposal is subject to detailed review by the Finance Ministry as it prepares the upcoming Union Budget. There is no certainty that the tax will be removed, or if it is, whether it will be applied in the exact form proposed by the regulator.
Market Fundamentals vs. Tax Policy
Market analysts caution that tax relief alone may not be enough to reverse the trend of outflows. While a reduction in the tax burden could provide a marginal improvement in post-tax returns, FPI flows are driven by a variety of factors. These include corporate earnings growth, current market valuations, currency stability, and shifts in global interest rates. Even with tax changes, the primary drivers for foreign investment remain the underlying strength of the Indian economy and the performance of its listed companies.
Investors should monitor the upcoming Union Budget 2027-28 announcements for clarity on this matter. The key indicator to watch will be the official government stance on capital gains taxes for non-resident investors, as any official policy shift would likely influence the regulatory framework for foreign capital in India.