SEBI Proposes Eliminating LTCG Tax for Foreign Investors, Offers Mutual Fund Relief

The Securities and Exchange Board of India (SEBI) has put forward recommendations aimed at reforming the long-term capital gains (LTCG) tax structure to attract foreign investment and support domestic mutual fund investors. These suggestions come as part of the preparations ahead of the federal budget scheduled for February 2027.

According to two individuals familiar with the matter, SEBI has advised the government to abolish the LTCG tax currently levied on foreign investors. This move is intended to revitalize India’s equity markets, which have underperformed compared to other emerging economies in recent years. Foreign investors have withdrawn a record $31 billion from Indian equities in 2026, while retail investors from overseas have increased their stakes amid stagnant returns.

In addition to targeting foreign investment, SEBI has proposed tax relief measures for domestic mutual fund participants. The regulator recommends exempting capital gains tax on transactions where investors switch from one mutual fund scheme to another, provided the units have been held for more than a year. This step aims to encourage investors to maintain their participation in domestic funds rather than exit amid market fluctuations.

While these recommendations are part of SEBI’s official budget proposals, the final decision rests with the government. The suggestions remain confidential and have not been publicly disclosed prior to this report. SEBI and the finance ministry have not responded to requests for comments.

India’s equity market has faced challenges over the last two years. The benchmark Nifty 50 index declined by 4.8% during this period, contrasting with a 40% rise in the MSCI Emerging Markets Index. Mutual fund returns have also been subdued, with large-cap equity funds generating an average negative return of 1.6%, according to Morningstar data. This sluggish performance has contributed to investor caution.

SEBI’s engagement with foreign investors over the past two years has been extensive, with multiple discussions focused on concerns regarding the tax structure. One consistent theme from these talks has been the request for tax reforms that reduce upfront tax liabilities on capital gains for foreign stakeholders.

Currently, foreign investors are subject to a 12.5% LTCG tax on securities held for more than one year, a 20% short-term capital gains tax for holdings under a year, along with securities transaction taxes on trades and withholding taxes on dividends. SEBI highlighted that transaction costs in India are among the highest globally, which can deter investment inflows.

Analysts from brokerage firms have weighed in on the proposed tax changes. Jefferies noted that any cut in capital gains taxes would enhance the appeal of Indian equities to international investors and support positive portfolio inflows. IIFL, another brokerage, estimated that eliminating the LTCG tax could boost foreign investors’ net returns by approximately 2.3 percentage points.

Domestic mutual funds currently manage assets totaling 82.6 trillion rupees (about $870.8 billion), with monthly net inflows averaging around 30 billion rupees. The recommended tax exemption on switching schemes seeks to reduce the friction investors face when adjusting their portfolios, potentially increasing investor confidence and participation in the fund market.

The proposals reflect SEBI’s broader goal of strengthening India’s capital markets by creating a more investor-friendly environment. With foreign investors playing a crucial role in market liquidity and valuation, easing tax burdens is viewed as a critical step to reversing outflows and stimulating growth.

As India prepares for the upcoming budget, these recommendations could influence government policy on taxation and market regulation. Any changes made could have significant implications for both foreign and domestic investors navigating the Indian equity landscape.