In a significant development from New Delhi, foreign portfolio investors (FPIs) have formally requested a comprehensive review of the tax framework applicable to them, with a particular emphasis on capital gains taxation. This move comes against the backdrop of persistent outflows from the Indian equity markets, raising concerns about the country's investment climate.
Key Concerns Raised with Regulators and Government
According to sources familiar with the ongoing deliberations, the issue has been escalated to both the Securities and Exchange Board of India (Sebi) and relevant government officials. The investors have repeatedly stressed the critical need for greater certainty and predictability in India's tax policies to foster a stable investment environment.
High Cost of Trading and Double Taxation Woes
Representatives of FPIs have highlighted that the cost of trading in India remains prohibitively high due to a multitude of levies and charges. These include brokerage fees, stamp duty, securities transaction tax (STT), Sebi turnover fees, exchange transaction fees, and custody fees. Beyond these operational costs, a more pressing issue has been identified: the problem of double taxation for certain overseas investors.
The double taxation dilemma arises from the current tax structure. FPIs themselves are subject to capital gains tax on their investments in Indian securities. Subsequently, when these funds distribute returns to their investors abroad, those individual investors can face taxation again in their home countries. This creates a layered tax burden that diminishes net returns.
Challenges with Foreign Tax Credits
Compounding this issue is the practical difficulty in utilizing foreign tax credits. In theory, the capital gains tax paid by the FPI in India should be available as a credit to offset the tax liability of the end-investor in their home country. However, tax experts note that these credits are often unavailable or exceedingly difficult to obtain in practice.
"This complication stems primarily from the typical structure of investments, which are made through funds, and the inherent complexity of foreign tax credit regimes across different jurisdictions," explained a seasoned tax expert familiar with the matter.
India's Unique Tax Position and Historical Context
The FPI community has pointed out that India stands among a select few nations globally that impose both a securities transaction tax (STT) and a capital gains tax on equity investments. This was not always the case. The landscape has shifted significantly over the past two decades.
- Prior to 2004, capital gains on listed equity securities were taxable in India.
- In 2004, with the introduction of STT, long-term capital gains (LTCG) on listed equities were abolished.
- This changed in 2018 when LTCG on listed equity transactions was reinstated at a rate of 10% above a specified threshold.
- This rate was subsequently increased to 12.5% in the previous year, adding to the cost burden for investors.
Impact on Market Attractiveness and Operational Hurdles
A tax specialist from a premier consulting firm observed that the cumulative effect of high costs and tax complexities is eroding the attractiveness of the Indian market for foreign capital at present. In addition to the primary tax concerns, FPIs have also flagged several operational and compliance-related challenges.
- Computation Issues: Difficulties in accurately calculating tax liabilities under the current rules.
- Restrictions on Loss Set-Off: Limitations on offsetting capital losses under specific scenarios, which can trap investors in unfavorable positions.
- Refund Delays: Protracted timelines for receiving tax refunds, which adversely impacts cash flow and investment planning.
The Scale of the Outflow Challenge
The urgency of these requests is underscored by the recent trend of foreign capital exiting Indian equities. Data reveals a concerning pattern of net sales by FPIs.
So far this year, FPIs have been net sellers of equity to the tune of approximately Rs 33,600 crore. This represents the highest monthly outflow since August of the previous year, when sales peaked at around Rs 35,000 crore. Looking at the broader picture, data from the NSDL website indicates that in the calendar year 2025, the net sales by FPIs were estimated at nearly Rs 1.7 lakh crore, highlighting a sustained period of significant withdrawal.
This confluence of substantial outflows and vocal concerns over the tax regime presents a critical juncture for policymakers. The decisions made in response to these FPI representations could have a profound impact on India's ability to attract and retain foreign investment in the coming years.
