Mumbai: The Securities and Exchange Board of India (SEBI) has recommended removing the 12.5% long-term capital gains (LTCG) tax on foreign investors' equity investments as part of its pre-Budget proposals to the government ahead of the Union Budget in February 2027.

To advertise here,

According to a Reuters report, the market regulator has also proposed tax relief for domestic mutual fund investors. The recommendations are aimed at making Indian equity markets more attractive, reducing investment costs and encouraging greater participation in the country's financial markets.

The proposals are not binding, and the government will take the final decision on whether to accept them, Reuters reported, citing two sources familiar with the matter.

What has SEBI proposed on LTCG tax?

SEBI has suggested exempting foreign investors from the 12.5% LTCG tax currently applicable to equity investments held for more than 12 months.

Under the existing tax structure, gains from listed equity investments held for up to 12 months are classified as short-term capital gains and taxed at 20%. Long-term gains exceeding the applicable annual exemption threshold are taxed at 12.5%. Securities transaction tax and applicable taxes on dividends also add to the overall cost of investing.

The regulator believes that reducing the tax burden could improve post-tax returns for foreign investors and make Indian equities more competitive when compared with other emerging markets.

One source quoted by Reuters said the proposals were aimed at reducing the upfront tax burden on foreign investors.

Why is SEBI pushing for tax relief?

The recommendations come amid sustained selling by foreign investors in Indian equities. According to the Reuters report, foreign investors have sold a record $31 billion worth of Indian stocks this year, while overseas investments by retail investors have increased as domestic market returns remained subdued.

SEBI's proposals also follow several meetings between the regulator and foreign investors over the past two years. Taxation was reportedly among the recurring concerns raised during these discussions.

The regulator has argued that transaction costs associated with equity investments in India are among the highest across jurisdictions. Lower capital gains taxes could improve the returns investors receive after taxes and potentially encourage more foreign capital to flow into domestic markets.

Brokerage firm IIFL estimates that scrapping capital gains tax could increase foreign investors' returns by 2.3 percentage points, according to Reuters.

What has SEBI proposed for domestic mutual fund investors?

SEBI has also sought tax relief for domestic mutual fund investors.

One of its recommendations is that switching from one mutual fund scheme to another should not be treated as a taxable sale if the investor has held the units for more than one year.

Under the existing framework, switching between mutual fund schemes is generally treated as a redemption from the original scheme followed by a fresh investment in another scheme. This can trigger capital gains tax, depending on the nature of the fund and the holding period.

SEBI's proposal seeks to reduce this tax liability for eligible investors and make it easier for them to move between schemes without facing an immediate tax burden.

Indian markets have underperformed emerging market benchmarks

SEBI's recommendations come against the backdrop of relatively subdued performance in Indian equities.

According to the figures cited in the Reuters report, the Nifty 50 has declined 4.8% over the past two years, while the MSCI Emerging Markets Index has gained 40% during the same period.

Average returns from large-cap domestic equity mutual funds have also fallen by 1.6%, according to Morningstar data cited in the report.

These trends have added to concerns about India's ability to attract and retain foreign investment amid competition from other emerging economies.

What could the proposals mean for Indian markets?

1. Potential boost to foreign investment

Removing LTCG tax for foreign investors could improve the post-tax returns from Indian equities. This may make domestic stocks more attractive to global funds comparing investment opportunities across emerging markets. However, taxation is only one factor influencing foreign investment decisions. Market valuations, economic growth, currency movements and regulatory stability also matter.

2. Possible relief for domestic mutual fund investors

If the proposed mutual fund switching exemption is accepted, investors who have held units for more than a year could potentially move between schemes without triggering an immediate capital gains tax liability. This could offer greater flexibility in managing portfolios.

3. A response to foreign investor outflows

The reported $31 billion in foreign equity selling highlights the challenge facing Indian markets in attracting overseas capital. SEBI's recommendations indicate that the regulator is considering changes to the taxation framework as one way to address investor concerns.

4. No immediate change in tax rules

The proposals are recommendations submitted ahead of the Union Budget, not changes to existing tax laws. Investors will continue to be governed by the current tax provisions unless the government announces and implements amendments.

Ultimately, the impact will depend on which recommendations the government accepts and how any proposed exemptions are structured.