Securities and Exchange Board of India Proposal May Lift FPI Returns

Securities and Exchange Board of India has recommended removing long-term capital gains tax for foreign equity investors, a step that could raise their returns by an estimated 2.3 percentage points. The recommendation is not binding, and the government will decide whether to include any tax change in the Union Budget expected in February 2027.

What has SEBI proposed for foreign investors?

SEBI has recommended that the government remove long-term capital gains tax on foreign investors' equity holdings. The proposal is intended to reduce the tax burden faced by overseas investors and improve the attractiveness of Indian equities at a time of weak market performance and sustained foreign selling.

The regulator has also proposed tax relief for domestic mutual fund investors, according to the reports. However, the foreign-investor LTCG proposal has drawn particular market attention because foreign portfolio flows have been under pressure. The recommendation comes months before the annual federal budget, but it does not represent a policy decision. The government retains the final authority over tax rules and may weigh the proposal against revenue and broader tax-policy considerations.

How much capital gains tax do foreign investors pay in India?

Foreign investors currently pay a 12.5% tax on long-term gains from securities held for more than one year. They pay 20% on short-term gains, alongside securities transaction tax on trades and withholding tax on dividends. The proposed change concerns the long-term levy, not the reported short-term rate.

These costs form part of the total return calculation for overseas investors. One source cited in the reports said the aim is to reduce the upfront tax burden on foreign investors. A potential change would therefore affect post-tax returns rather than the operating performance or valuations of listed companies directly.

Could removing LTCG tax bring foreign portfolio flows back?

Removing LTCG tax could improve the relative appeal of Indian equities, but brokerages do not present it as a guaranteed trigger for a market rally or immediate large inflows. Jefferies said that lower capital gains taxes could make the market more attractive for foreign investors and support portfolio inflows. IIFL estimated that scrapping capital gains tax could lift foreign investors' returns by 2.3 percentage points.

JM Financial offered a more qualified view, saying an LTCG removal would increase the response of flows when markets rise rather than create the rise itself. Its bull-case estimate was that tax relief could add $3 billion to $5 billion to FY28E inflows. It also said eliminating LTCG would add roughly 2.2 percentage points to an average year's dollar return, comparable with the average drag from the rupee.

The discussion follows heavy foreign selling. Reports cited record net foreign investor outflows of $31 billion this year, while another market discussion referred to $64 billion of outflows over the past two years. India’s Nifty 50 was reported to have fallen 4.8% over two years, compared with a 40% gain for the MSCI emerging markets index over the same period. These figures help explain why a tax change is being discussed as one measure to improve investor sentiment.

Which Indian market segments could benefit from returning foreign flows?

Banks, energy, utilities and real estate could benefit if foreign investment flows recover, according to market commentary cited in the discussion. Reliance Industries was also identified in social-media summaries as a potential beneficiary. These are possible flow-based effects, not an indication that the proposal changes the fundamentals of any company or sector.

Foreign participation can matter especially in widely held, liquid stocks, but tax relief would be only one factor in allocation decisions. JM Financial said valuation remains the larger consideration. Currency movements, the market’s relative performance, transaction costs and the tax treatment available to foreign investors in their home jurisdictions may also affect how investors assess Indian equities.

What could prevent the proposal from becoming policy?

The main constraint is that SEBI’s recommendation is not binding on the government. The government may consider the potential revenue impact, fiscal constraints and its objective of converging taxation across asset classes before deciding on any reduction or exemption.

The reported figures underline that trade-off. Equity LTCG tax and securities transaction tax together accounted for around 8% of direct tax collections and 5% of gross tax revenue in FY25, according to the cited market report. Unconfirmed market discussions have also included alternatives such as a broader reduction in LTCG and short-term capital gains tax rates, a targeted FPI exemption, or allowing foreign investors to calculate gains in dollar terms. None of these alternatives has been confirmed as government policy.

Conclusion

SEBI’s recommendation has put tax competitiveness at the centre of the discussion around foreign participation in Indian equities. Eliminating the 12.5% LTCG tax could improve foreign investors’ post-tax returns by about 2.3 percentage points and may support flows, but the evidence cited by brokerages suggests it would complement rather than replace valuation, currency and market-performance considerations.

The next key event is the Union Budget expected in February 2027, when the government could clarify whether it accepts, modifies or does not pursue the recommendation. Investors will also watch foreign portfolio flow trends, the rupee and whether the government addresses the reported revenue and tax-policy concerns.