Could Eliminating LTCG Tax Attract Foreign Investors Back to the Market?

India’s long-term capital gains (LTCG) tax is increasingly viewed as a barrier for investors, contributing to a notable exodus of foreign capital from the country’s stock market. This tax, which was introduced in 2018, applies to both domestic and foreign investors and is seen as a unique aspect of India’s financial landscape. While major global markets like the US, Singapore, and the UK do not impose such taxes, India’s stock market has not reached a new closing high in over two years, raising concerns among investors.

Understanding LTCG Taxation in India

In India, the LTCG tax applies to shares held for more than 12 months, with a rate of 12.5%. Investors can claim an annual exemption of Rs 1.25 lakh across listed shares and equity mutual funds. For shares held for less than a year, a short-term capital gains (STCG) tax of 20% is applicable. Additional levies, such as health and education cess, can raise the effective rates to 15% and 24%. Investors also incur a Securities Transaction Tax (STT) on each trade, which varies for cash equities and derivatives.

Calls for LTCG Removal

The Indian equity benchmarks, Nifty50 and BSE Sensex, are experiencing significant declines this year, with projections indicating the worst annual performance in over a decade. In contrast, the MSCI Emerging Markets Index has risen by 40% in the same period. This disparity has led to increasing demands for the removal of the LTCG tax, particularly from foreign investors. The Securities and Exchange Board of India (SEBI) has urged the government to reconsider this tax, while State Bank of India (SBI) has suggested extending the holding period for equities to 2-3 years and abolishing the LTCG tax to attract more foreign capital.

Finance Minister Nirmala Sitharaman has acknowledged the growing concerns regarding the LTCG tax. She stated that the government would consider requests for changes to the capital gains tax structure, indicating a potential shift in policy.

Impact of LTCG on Foreign Investment

Foreign Portfolio Investors (FPIs) withdrew $19 billion in 2025 and approximately $30 billion in 2026, with a significant portion redirected to investments in artificial intelligence. Experts argue that eliminating the LTCG tax could enhance India’s tax competitiveness, making it more appealing to global fund managers. However, they caution that taxation is just one factor influencing investment decisions. Other markets, such as China and South Korea, offer attractive valuations and opportunities that may overshadow India’s appeal.

Removing the LTCG tax could improve sentiment and encourage foreign investors to reconsider their allocations to India. However, experts emphasize that it is not a panacea for the challenges facing the Indian stock market. The government collected around Rs 1.29 lakh crore in equity LTCG tax in FY25, compared to Rs 72,249 crore in the previous year, but this revenue should not be seen as a loss of capital inflows.

Broader Economic Factors at Play

Several factors contribute to the current outflow of foreign capital, including high stock market valuations, geopolitical uncertainties, and rising crude oil prices. While the LTCG tax exacerbates these issues, it is not the sole cause of the trend. Despite recent budget changes, the stock market has not seen a resurgence, indicating that broader economic conditions play a significant role in investor behavior.

Experts suggest that while removing the LTCG tax could be beneficial, it will not resolve all underlying issues. The sustainability of foreign investment flows will depend on improvements in corporate earnings, valuations, and overall macroeconomic stability.