SEBI Recommends Scrapping 12.5% LTCG Tax on Foreign Investors as IVCA Urges Parity with Domestic Capital

In a bid to revive India's equity markets following heavy overseas outflows, the Securities and Exchange Board of India (SEBI) has formally submitted pre-budget representations to the Union Ministry of Finance recommending the complete scrapping of the 12.5% Long-Term Capital Gains (LTCG) tax on foreign portfolio investors (FPIs). At the same time, the market regulator has recommended that domestic retail investors be exempted from capital gains tax when switching between mutual fund schemes after a holding period of more than one year.

The regulator's pitch arrives at a critical juncture for Dalal Street. Overseas investors have pulled a record $31 billion out of Indian equities, leaving domestic benchmark indices such as the Nifty 50 trailing behind broader emerging-market peers.

High Transaction Costs and FPI Outflows

Foreign funds participating in Indian capital markets currently face a layered tax regime. Beyond the 12.5% LTCG tax on securities held for more than 12 months, foreign investors are subject to a 20% Short-Term Capital Gains (STCG) tax, standard Securities Transaction Tax (STT) on trades, and withholding taxes on dividend income.

SEBI has repeatedly acknowledged during stakeholder consultations that transaction costs associated with investing in Indian equities rank among the highest across global jurisdictions.

Brokerage analysis underscores the direct financial drag caused by these levies:

• IIFL Finance: Estimates that abolishing the LTCG tax could increase net returns for foreign investors by approximately 2.3 percentage points.
• Jefferies: Noted that a rationalization of capital gains taxes would significantly enhance India's competitiveness compared to peer markets and provide immediate support to institutional portfolio inflows.

Domestic Mutual Fund Relief

On the domestic front, SEBI’s proposal seeks to dismantle tax friction for individual investors. Currently, moving capital from one mutual fund scheme to another—even within the same fund house—is classified by tax authorities as a redemption followed by a fresh purchase, triggering an immediate LTCG liability if held for over a year.

SEBI has proposed that switching between schemes after a one-year holding period should not be treated as a taxable sale. This reform aims to give retail investors the flexibility to rebalance their asset allocations without facing an upfront tax penalty, encouraging long-term capital retention within the domestic mutual fund ecosystem.

IVCA Demands Parity for Domestic Capital

While SEBI's proposal focuses heavily on easing terms for foreign institutional capital in public equities, leaders at the Indian Venture and Alternate Capital Association (IVCA) are cautioning against widening the asymmetry between foreign and domestic investors.

IVCA representatives have consistently urged North Block to institute a level playing field across domestic and overseas risk capital, as well as between listed equities and unlisted private market investments. Industry leaders point out that domestic Alternate Investment Funds (AIFs), private equity funds, and venture funds have shouldered disproportionate tax burdens and regulatory compliance costs compared to overseas counterparts investing via foreign direct investment (FDI) or favorable bilateral tax channels.

Alternative asset managers argue that while attracting foreign currency inflows is vital to supporting the rupee and public equity valuations, India's long-term economic resilience requires unlocking deep domestic institutional balance sheets—such as pension funds, provident funds, and insurance companies—under tax terms that do not penalize local asset creators.

Budget 2027 Outlook

Because SEBI's pre-budget proposals are advisory, the final decision on whether to adopt, modify, or reject the abolition of the 12.5% LTCG rate rests with the Ministry of Finance.

If the government acts on SEBI’s suggestions, it could mark one of the most substantial overhauls of India's capital market taxation since the reintroduction of equity capital gains taxes, with market participants eagerly watching whether North Block chooses targeted relief for overseas funds or a broader rationalization across both domestic and foreign investment pools.