Capital gains tax on FPIs comes in the way of India’s ambition to become a global investment hub

There are moments in a nation's economic evolution when a seemingly modest policy change has the potential to trigger gains far greater than its immediate fiscal pain. India stands at such a moment today, with the question before policymakers: should India continue to levy capital gains tax (CGT) on equity investments held by FPIs?

If CGT on FPI equity investments is removed, revenue forgone would be an estimated 15-20 bps of GDP. Against that stands the prospect of a lasting reduction in India's cost of capital, stronger foreign capital inflows and faster long-term economic growth. Few policy choices offer such an attractive trade-off.

The debate is often framed as one of fairness between domestic and foreign investors. That is wrong. The right perspective is to compare India with every other destination competing for global savings. Capital today is mobile and unforgiving. It flows not merely towards opportunity but away from friction. If nearly every major competing market has eliminated this friction, why shouldn't we do so, too?


India is the only major economy that taxes FPIs on a source basis. Most competing markets allow investors to pay CGT in their home jurisdictions, thereby avoiding double taxation and unnecessary administrative complexity. This distinction is not a mere technicality. It alters investment behaviour.

Under prevailing accounting standards, international funds must provide daily for potential Indian CGT liabilities, even on unrealised gains, reducing NAV available to investors exiting the fund. Yet, those investors frequently cannot claim corresponding tax credits at home, even with the help of a tax treaty, because the tax has merely been provided for rather than paid.

Even where gains are realised, legal separation between the investment fund and the ultimate investor often prevents realisation of effective tax credits. Pension funds, university endowments, sovereign investors and tax-exempt retirement accounts are particularly disadvantaged since many have no domestic tax liability against which Indian taxes can be offset. Note that this is only about FPIs, not FDI. The cumulative consequence is substantial.

Estimates indicate that these frictions reduce post-tax returns to foreign investors by roughly 2.4 percentage points annually. A portfolio expected to compound at 13% in rupee terms ultimately delivers only about 8.4% after taxes and related frictions. Once ordinary rupee depreciation is incorporated, effective dollar-return falls to barely 4.4%. At those levels, India is no longer competing on its economic fundamentals alone. It's competing while voluntarily carrying additional weight.

This isn't merely an academic calculation. FPIs repeatedly point to chronic underperformance of the MSCI India ETF relative to MSCI index. Some drag is natural because of transaction costs and fees. But in our sample of 21 countries, India consistently ranks in the 4th quartile on this measure.

Dividend tax and transaction taxes can't explain this, because Indian rates are broadly in line with international norms. CGT is the most likely differentiating factor. The result is that fund managers find it more difficult to secure fresh India mandates, even when India's underlying economic prospects remain compelling. But can India afford to surrender this revenue? More importantly, is CGT on FPIs a luxury India can afford?

India remains a structurally CAD economy. Such economies cannot afford to treat foreign capital as an afterthought. Every unnecessary impediment imposed upon capital ultimately manifests itself as a higher cost of equity and investment, slower corporate expansion, lower employment creation and, ultimately, slower economic growth - and lower tax revenues.

Taxes don't merely raise revenue. They also alter incentives. A tax that materially discourages capital inflows imposes costs extending far beyond the revenue it collects. The revenue involved is modest when viewed against GoI's excellent progress on broader fiscal consolidation in recent years. Attempting to preserve revenues by sharply increasing securities transaction tax (STT) would merely substitute one friction for another, requiring transaction taxes to rise dramatically to break even.

Great economic powers do not merely build roads, ports and factories. They also build financial systems through which capital moves with confidence. They become prosperous not by taxing capital more heavily than their competitors but by attracting more of it.

India has already undertaken difficult reforms across infrastructure, manufacturing, digitalisation, logistics and macroeconomic management. Having travelled so far, it would be unfortunate to miss the chance to sharply reduce the cost of capital, one of the 4 factors of production, and catalyse progress on all these reforms.

The tax should be axed in its entirety, not just reduced. Already there have been too many changes, too frequently, compared to the decades-long consistency seen in other countries. Abolition of CGT on FPIs won't represent a concession to overseas investors, but would represent a strong message of commitment to minimising India's long-term cost of capital.