SEBI Proposes Scrapping 12.5% LTCG Tax for Foreign Funds to Stem Outflows
In a bid to enhance the competitiveness of Indian equity markets and stem relentless overseas outflows, the Securities and Exchange Board of India (SEBI) has submitted pre-budget recommendations to the central government urging the complete removal of the 12.5 percent Long-Term Capital Gains (LTCG) tax on foreign portfolio investors (FPIs). Alongside this relief, the capital markets regulator has also proposed tax exemptions for domestic mutual fund investors who switch between schemes after holding units for more than 12 months.
The recommendations, submitted ahead of the Union Budget in February, are non-binding, with the final policy decision resting with the Ministry of Finance.
HDFC Securities Calls Proposal a Step in the Right Direction
Welcoming the regulator's recommendations, Dhiraj Relli, Managing Director and CEO of HDFC Securities, stated that abolishing the LTCG tax has been one of the primary demands of global institutional investors.
"That's where they want long-term capital gains taxes to be abolished, and that's something they have been looking forward to and demanding," Relli said in an interaction with ANI. Terming the move "a very good thing and step in the right direction," he noted that the measure would prove positive for Indian capital markets at large.
Foreign investors have offloaded a record $31 billion (approximately Rs 3.07 lakh crore) from domestic equities in 2026 amid global macro headwinds, elevated valuations, and currency pressures. Relli pointed out that while tax tweaks alone do not dictate underlying economic expansion, easing the tax regime can significantly improve foreign market sentiment.
"Taxations will not directly impact the GDP growth," Relli observed, explaining that broader gross domestic product growth depends on domestic consumption, government capital expenditure, and grounded manufacturing and services activity. However, he emphasized that eliminating the LTCG levy could "arrest the outflows by foreign portfolio investors who've been relentlessly selling in Indian markets because they find Indian market less attractive when it comes to the dollar returns."
High Transaction Costs and Existing Tax Burdens
Over recent quarters, Indian equities have trailed several emerging market counterparts. During regulatory consultations, overseas funds have consistently raised concerns over India’s multi-layered taxation structure and high overall transaction friction.
Under the existing tax framework, foreign investors are subject to several levies:
- A 12.5 percent long-term capital gains tax on equity holdings sold after a holding period of more than one year.
- A 20 percent short-term capital gains (STCG) tax on shares liquidated within 12 months.
- Securities Transaction Tax (STT) charged upfront on market transactions.
- Mandatory withholding taxes on domestic dividend distributions.
Relief on the Table for Domestic Mutual Fund Investors
In addition to foreign investor sops, SEBI’s pre-budget representation seeks to prevent tax drag for retail participants staying within the formal financial system. Under current tax rules, switching capital from one mutual fund scheme to another is treated as a redemption, triggering capital gains liabilities even if the money remains invested in the mutual fund ecosystem.
SEBI has recommended that scheme switches held for more than one year should be exempt from LTCG tax, encouraging domestic investors to realign their portfolios across asset classes without an immediate tax penalty.
The proposals now await consideration by the Union Finance Ministry during budget deliberations. If accepted, the removal of the LTCG levy could materially alter post-tax yields for international institutional capital, providing vital liquidity support to the domestic equity benchmarks.
