Could India Eliminate Long-Term Capital Gains Tax to Attract Foreign Investors?
Mumbai's Market Regulation Proposal
Mumbai: India's market regulator has advised the government to consider abolishing the long-term capital gains (LTCG) tax for foreign investors, according to sources familiar with the discussions. This move aims to invigorate India's sluggish equity markets. The Securities and Exchange Board of India (SEBI) has also suggested tax exemptions for domestic mutual fund investors, proposing that they should not incur LTCG taxes when selling existing investments to reinvest in new ones. These recommendations, which are not mandatory and will ultimately be decided by the government, come ahead of the federal budget scheduled for February. SEBI's suggestions follow numerous meetings with foreign investors over the past two years, during which persistent selling has exerted pressure on the Indian rupee. Investors have consistently expressed the need for a revision in India's tax policies.
Attracting Foreign Investment
SEBI has pointed out that the costs associated with equity investments in India are among the highest globally. Currently, foreign investors face a long-term capital gains tax of 12.5% for securities held over a year, alongside a short-term capital gains tax of 20%, plus additional securities transaction taxes and withholding taxes on dividends. A recent note from brokerage firm Jefferies indicated that lowering capital gains taxes could enhance the market's appeal to foreign investors and boost portfolio inflows. IIFL, another brokerage, estimates that eliminating the capital gains tax could increase returns for foreign investors by 2.3 percentage points. Samir Arora, founder and fund manager at Helios Capital Management in Singapore, remarked that India is one of the few nations where foreign investors are taxed on capital gains, and rectifying this situation would be positively received by all investors.
Support for Domestic Mutual Fund Investors
Over the past two years, India's benchmark Nifty 50 index has dropped by 4.8%, while the MSCI emerging market index has surged by 40%. Returns from diversified domestic equity mutual funds, which have become a popular saving method for retail investors, have also stagnated during this period. Data from fund research firm Morningstar shows that average returns from large-cap stock funds have decreased by 1.6%. To encourage continued investment in domestic mutual funds, SEBI has proposed that switching between mutual fund schemes should not be classified as a taxable sale if the units have been held for over a year. Currently, Indian mutual funds manage assets worth ₹82.6 trillion ($870.80 billion), with an average of ₹30 billion being invested monthly through systematic investment plans. Vivek Rajpal, an Asia macro strategist at JB Drax Honore, stated that this is an opportune moment for such tax reforms. He emphasized that removing the long-term capital gains tax would align India with other emerging markets and enhance its attractiveness to foreign investors.