Tax matters, as does capital: Is it time for India to reconsider its LTCG tax policy on listed equities amid rising global competition?

Last week, Nirmala Sitharaman called the debate on long-term capital gains (LTCG) tax and securities transaction tax (STT) healthy, welcoming differing views. No change was announced, but Sensex soared by over 1,100 points.

FPIs have pulled out about ₹3.08 lakh cr from equities this year as of Oct 12. Taxation is not the sole explanation. Global interest rates, competing markets, Indian valuations, earnings expectations and rupee depreciation all influence investment decisions. But neither can tax be dismissed. When capital moves across borders, return after tax matters. So, should India abolish LTCG on listed equities?

GoI informed Parliament that tax attributable to LTCG on equity transactions amounted to ₹1,29,158 cr for AY2025-26, up from ₹72,249 cr the previous year. These figures don't isolate listed shares or FPI contribution. Nor would abolition necessarily cost the entire amount. Its scope, investor behaviour and market conditions matter. The revenue at stake, nevertheless, warrants serious analysis.

Could higher STT compensate? That is hardly attractive. STT applies whether investors profit or lose. Increasing it further could impair liquidity and market efficiency. Nor can we assume that a market rally following abolition would automatically replace lost tax revenue.

Taiwan doesn't tax securities gains. Brazil offers favourable treatment to qualifying non-resident portfolio investors, subject to conditions. Vietnam taxes gross securities-transfer proceeds rather than gains. South Korea's rules depend, among other things, on shareholding and treaty provisions. These regimes differ, as do their transaction levies. Yet, India's additional LTCG tax can put it at a disadvantage.

LTCG rate of 12.5%, plus applicable surcharge and cess, is not especially high by Indian standards. But international investors compare after-tax returns across markets. A modest domestic rate becomes meaningful when a competing market imposes no corresponding tax.

Consider who bears it. Sovereign wealth funds, pension funds and other long-term institutions may be tax-exempt at home. For them, Indian LTCG can be a final cost, with no home-country tax against which to claim credit. India grants targeted relief to specified sovereign wealth and pension funds for eligible investments, notably infrastructure. That's not general exemption for listed-equity portfolios.

Currency movements make matters worse. An FPI buys a share at ₹100 and sells at ₹120, a 20% rupee gain. If meanwhile, dollar appreciates 20% against rupee, the investor has made nothing in dollars, yet pays tax on the rupee gain. Indian law allows foreign currency computation in specified non-resident cases. But the special FPI regime doesn't extend that protection to listed-equity gains. With indexation unavailable for these gains, the case for revisiting currency-related distortions deserves attention.

Foreign investors worry as much about certainty as about rates. Mauritius illustrates why. Supreme Court upheld the treaty route in the 2003 'Union of India v. Azadi Bachao Andolan'. The 2016 protocol preserved protection for qualifying shares acquired before April 1, 2017.

The top court's January 'Authority for Advance Rulings v. Tiger Global International II, III, and IV Holdings' ruling raised questions about domestic general anti-avoidance rules, followed by rule amendments in March. Separately, the treaty's principal purpose test operates under its own framework: the tax administration has clarified that grandfathered investments fall outside it. These are distinct issues. But the sequence makes it difficult to assess confidently the consequences of investments made years earlier.

Robust anti-avoidance rules are legitimate. Investors can't demand an unchanging regime. But changes must be clear, prospective where appropriate, and consistently administered. Years spent resolving disputes are themselves an investment cost.

FM must not reduce consultation to a choice between retaining and abolishing LTCG. GoI should assess revenue and investment implications of abolition for listed equities, a lower rate and targeted relief for longer-held investments. Each affects investors, market behaviour and the exchequer differently. Exempting foreigners alone would also raise questions of fairness and round-tripping.

India must also examine foreign currency computation for non-residents, remove ambiguity around grandfathered investments, and provide credible, time-bound dispute resolution. These reforms need not await a decision on the rate.

Here's an opportunity to make India a more competitive and predictable destination for global capital, beyond a one-day rally.