India’s markets regulator has recommended that the government scrap long-term capital gains (LTCG) tax for foreign equity investors, two people with direct knowledge of the matter said, as India looks to galvanise its underachieving equity markets.
The Securities and Exchange Board of India (SEBI) has also proposed tax relief for domestic mutual fund investors, the sources said. They said SEBI suggested that investors be exempt from LTCG when they sell existing holdings to invest in new ones.
The recommendations come months before the annual federal budget in February. They are not binding, and the final decision rests with the government. The sources declined to be named because the recommendations, which have not been reported before, are part of confidential pre-budget representations. Email queries sent to Sebi and the finance ministry were not answered.
India’s equity market has lagged its emerging market peers over the past two years. Foreign investors have sold a record $31 billion of Indian stocks this year, while overseas investments by retail investors have surged as returns have stagnated. SEBI's recommendations follow scores of meetings between the regulator and foreign investors over the last two years as selling persisted, putting pressure on the Indian currency. Investors have consistently urged changes to the tax system, the sources said.
Finance Minister Nirmala Sitharaman told a conference in Mumbai that India needs capital, especially equity, to sustain growth of more than 7%. She added that concerns over the tax regime had grown louder.
Investors now pay LTCG tax of 12.5% on securities held for more than a year, and short-term capital gains tax of 20%. They also pay securities transaction tax on trades and withholding tax on dividends. Sebi has said transaction costs of investing in Indian equities are among the highest anywhere.
Analysts and investors backed the idea of cutting the tax:
Brokerage Jefferies said in a note this week that any reduction in capital gains taxes could raise the market’s attractiveness for foreign investors and support inflows.
Brokerage IIFL estimates that scrapping the tax could lift foreign investors’ returns by 2.3 percentage points.
Gary Tan, portfolio manager for active equity at Allspring Global Investments, said scrapping both long- and short-term capital gains tax would be a clear positive, improving post-tax returns and removing a longstanding friction in allocating capital to India. He said it would not remove concerns that AI could erode India’s labour-cost-arbitrage growth model.
Samir Arora, founder and fund manager of Singapore-based Helios Capital Management, said India is one of the very few countries where foreign investors pay tax on capital gains, and that correcting this anomaly would be welcomed by all investors.
Vivek Rajpal, Asia macro strategist at JB Drax Honore, said this was probably the best time to undertake tax reforms. He said removing LTCG would help align India with other emerging markets and improve its relative attractiveness to foreign investors.
The benchmark Nifty 50 has fallen 4.8% in the last two years, while the MSCI emerging market index is up 40%. Average returns from diversified domestic equity funds that invest in large-cap stocks are down 1.6% over the period, according to Morningstar. Such funds have become a common way for retail investors to save.
To encourage investors to stay in domestic mutual funds, SEBI has recommended that switching from one mutual fund scheme to another should not be treated as a taxable sale if the units were held for more than a year, the sources said.
Indian mutual funds hold 82.6 trillion rupees ($871 billion) in assets under management, with an average of 30 billion rupees flowing in each month through monthly investment schemes.