Budget 2026: Will LTCG Tax Reforms Revive Indian Equities?

Introduction: Capital Gains Tax in the Spotlight

As India anticipates the Union Budget for 2026-27, the long-term capital gains (LTCG) tax regime has become a central topic of discussion among investors, policymakers, and market analysts. With the new Income-tax Act, 2025, scheduled to take effect on April 1, 2026, the government has a prime opportunity to rationalize capital gains provisions. This comes after a period of muted market returns and significant outflows from foreign portfolio investors (FPIs), raising expectations for tax relief measures that could rejuvenate market sentiment.

The Current Tax Framework

The Union Budget 2024 introduced substantial changes to simplify the capital gains tax structure. The government raised the Short-Term Capital Gains (STCG) tax on listed equities from 15% to 20% and the LTCG tax from 10% to 12.5%. To provide some relief to retail investors, the tax-exemption threshold for LTCG was increased from ₹1 lakh to ₹1.25 lakh per financial year. A significant change was the withdrawal of indexation benefits, which previously adjusted the purchase price of an asset for inflation. The holding period was also simplified: one year for listed securities to qualify for LTCG and two years for all other assets.

Why Reforms Are Expected in Budget 2026

The primary driver behind the call for tax reforms is the challenging market environment of the past year. In 2025, foreign institutional investors withdrew over ₹1.66 lakh crore from Indian equities, the largest annual outflow on record. The selling pressure continued into January 2026, with an additional outflow of ₹33,598 crore. This sustained selling has weighed on market performance, leading many to believe that a more favorable tax regime could help attract foreign capital and boost domestic investor confidence.

Market participants are advocating for several key changes. A primary expectation is an increase in the LTCG exemption limit beyond the current ₹1.25 lakh. There are also strong calls to reduce the LTCG tax rate, possibly reverting to the previous 10% level. Further simplification, such as adopting a uniform one-year holding period across all asset classes, is another area of focus to reduce complexity and potential disputes.

The FPI Conundrum: Will a Tax Cut Bring Them Back?

A key argument for lowering capital gains tax is its potential to attract foreign investment. However, market experts are divided on its effectiveness. While a tax cut would improve post-tax returns at the margin, many analysts argue that FPI decisions are driven by broader macroeconomic factors. Global strategists point out that FPI outflows have been primarily influenced by rising US bond yields, a strengthening dollar, geopolitical uncertainty, and concerns about Indian corporate earnings growth, not the tax rate itself. For large global funds, factors like macroeconomic stability, earnings visibility, and currency risk often outweigh marginal tax considerations. A tax cut alone is unlikely to reverse a trend dictated by these powerful global forces.

A Look at Historical Precedents

India's history with capital gains tax offers valuable insights. In 2004, the government abolished the LTCG tax on equities and introduced the Securities Transaction Tax (STT). While this move was followed by a significant bull market, the rally was primarily fueled by strong economic growth, rising corporate profits, and abundant global liquidity. Conversely, the reintroduction of LTCG tax at 10% in 2018 caused a brief market sell-off, but the broader uptrend soon resumed, driven by underlying fundamentals. These historical examples suggest that while tax policy can influence short-term sentiment, it is rarely the primary driver of long-term market trends.

Implications for Corporate Restructuring

Beyond individual investors, the capital gains tax regime significantly impacts corporate activities. Experts suggest that extending tax-neutral treatment to outbound mergers, where an Indian company merges with a foreign one, could facilitate smoother cross-border reorganizations. Similarly, providing tax neutrality for intra-group slump sales, subject to certain conditions, would allow businesses to restructure more efficiently without immediate tax liabilities. Reforming the taxation of share buybacks is another area of concern, as the current rules can disproportionately affect shareholders and reduce the appeal of buybacks as a method for returning capital.

Conclusion: A Balancing Act for the Government

The Union Budget 2026 presents a strategic opportunity to refine India's capital gains tax framework. While a reduction in the LTCG tax rate or an increase in the exemption limit could provide a welcome short-term boost to market sentiment, it is unlikely to be a panacea for the challenges facing the market. The government must balance the need to boost investor confidence with the fiscal necessity of maintaining a stable revenue source. Ultimately, a sustained market recovery will depend less on marginal tax tweaks and more on fundamental drivers such as corporate earnings growth, government capital expenditure, and a supportive global economic environment.