Finance Ministry Weighs Slashing 12.5% LTCG Tax Rate and Introducing Dollar-Based Taxation for Foreign Investors

In the run-up to the Union Budget, the Ministry of Finance is actively considering structural revisions to India's capital gains tax regime to revive market sentiment and attract foreign capital. The proposals under review include lowering the current 12.5% long-term capital gains (LTCG) tax rate for both domestic and foreign investors, as well as allowing foreign portfolio investors (FPIs) to compute capital gains tax in US dollars rather than Indian rupees.

“We are discussing every option,” a senior government official told The Indian Express, confirming that policymakers are assessing whether reducing or scrapping capital gains tax could rekindle interest in the equity markets.

Addressing the Dollar-Rupee Friction

A central grievance among foreign investors has been the requirement to pay capital gains tax on profits calculated in rupee terms. Because the rupee depreciates over time against the US dollar, overseas funds often face tax liabilities on notional rupee gains, even when an investment yields flat or negative returns when converted back into dollars.

While non-residents have access to foreign currency conversion benefits under specific provisions for unlisted securities to cushion against currency depreciation, FPIs trading listed equities have remained excluded from such relief. Allowing dollar-based tax computations would align India with regional competitors such as China, Indonesia, and Brazil, which maintain nil or nominal capital gains taxes on foreign equity investments.

Key Drivers Behind the Government's Review

The urgency to address equity taxation stems from several macroeconomic and domestic market pressures:

• Equity Market Stagnation: Despite India's GDP growing at 7.8% in the April–June quarter, domestic benchmark indices have experienced a flat trajectory over the past two years, dampening the wealth-creation sentiment of middle-class households.
• Exhaustion of the Domestic Absorption Buffer: For roughly a decade, domestic mutual fund inflows consistently countered foreign portfolio exits. However, confidence in domestic funds' capacity to absorb persistent FPI outflows has faced strain.
• Shifts in Retail Participation: According to data from Prime Infobase, retail shareholding (defined as investors holding up to ₹2 lakh in shares) in NSE-listed companies climbed from 6.58% (valued at ₹7.23 lakh crore) in March 2020 to 7.66% (valued at ₹33.16 lakh crore) in June 2024, before declining to 7.12% (valued at ₹28.97 lakh crore) by March 2026. Despite the drop in aggregate value, overall retail engagement remains structurally high, with Central Depository Services Limited (CDSL) demat accounts surging to 19.34 crore in September 2026 from 2.12 crore in March 2020.
• Global Yield Competitiveness: Rising interest rates in developed markets and rich domestic equity valuations have encouraged global asset managers to redirect capital elsewhere, highlighting the friction created by India's 12.5% LTCG tax.

Precedents and Expert Recommendations

The deliberations follow earlier measures implemented by the Centre to reduce tax barriers for overseas capital. On June 5, the government eliminated withholding tax as well as short- and long-term capital gains taxes on foreign investments in government bonds. Prior to that waiver, overseas bondholders paid a 12.5% LTCG tax, a 30% short-term capital gains tax, and an approximate 20% withholding tax on interest income.

Calls for broader tax rationalisation have also emerged from state-backed research. In its Ecowrap report released on October 12, the State Bank of India (SBI) urged the government to review capital taxation to anchor foreign flows, recommending an extension of the qualifying holding period to two-to-three years alongside the complete abolishment of the long-term capital gains tax on equity holdings.