The Government has released a detailed set of Frequently Asked Questions (FAQs) clarifying the proposed tax exemption for Foreign Institutional Investors (FIIs) investing in Government Securities (G-Secs).
The clarification comes in the backdrop of proposed amendments under the Income-tax Act, 2025, which seek to exempt certain income earned by FIIs from investments in Government Securities. The move is expected to enhance the attractiveness of Indian government bonds for overseas investors and support the development of the domestic debt market.
What Is the Existing Tax Framework for FIIs?
Historically, interest income earned by foreign investors on specified Government Securities enjoyed tax exemptions under Section 10(15) of the Income-tax Act, 1961 until 2002. Subsequently, concessional taxation at 5% was provided for specified periods between 2013 and 2023.
Under the new Income-tax Act, 2025, FIIs are governed by a dedicated taxation framework under Section 210, which taxes income from securities and capital gains arising from their transfer.
Currently, income from securities is taxable at 20%, while short-term capital gains (STCG) and long-term capital gains (LTCG) are taxed at rates prescribed under Section 210, depending on their nature and eligibility for concessional treatment.
Who Qualifies as an FII?
According to Section 210(6)(a) of the Income-tax Act, 2025, a Foreign Institutional Investor (FII) refers to an investor notified by the Central Government. Foreign Portfolio Investors (FPIs) registered with SEBI have already been notified as FIIs for this purpose.
What Tax Relief Has Been Proposed?
The proposed ordinance seeks to exempt two major categories of income earned by FIIs from Government Securities:
- Interest income earned from Government Securities.
- Capital gains arising from the transfer or redemption of Government Securities.
This means that both recurring income and gains earned upon sale or redemption of eligible Government Securities may become tax-free for FIIs if the proposal is enacted.
Why Is the Exemption Significant?
Government Securities generally do not attract Securities Transaction Tax (STT). As a result, the concessional capital gains provisions available under Sections 196 and 198 of the Income-tax Act, 2025 are ordinarily not applicable to these securities.
In the absence of the proposed exemption:
- Short-term capital gains on Government Securities are generally taxable at 30%.
- Long-term capital gains are taxable at 12.5%.
The proposed exemption would therefore eliminate a substantial tax burden currently applicable to foreign investors in this segment.
Classification of Government Securities for Capital Gains
The FAQs clarify that the holding period determines whether a Government Security is treated as a short-term or long-term capital asset.
- Listed Government Securities become long-term assets if held for more than 12 months.
- Unlisted Government Securities become long-term assets if held for more than 24 months.
Securities held for shorter periods are treated as short-term capital assets.
Routes Available for FII Investments
FIIs and FPIs can invest in Government Securities through:
- General Route
- Fully Accessible Route (FAR)
The FAR route was introduced to facilitate greater foreign participation in select Government Securities without investment caps.
Definition of Government Security
For the purpose of the proposed exemption, the term "Government Security" will carry the meaning assigned under the Securities Contracts (Regulation) Act, 1956. It includes securities issued by the Central Government or State Governments for raising public loans.
Current FII Exposure to Government Securities
The FAQs also provide an overview of foreign investor participation in India's government bond market as on May 12, 2026:
General Route
- FPI holdings: ₹54,091 crore
- Outstanding stock: ₹64.78 lakh crore
- Shareholding: 0.83%
Fully Accessible Route (FAR)
- FPI holdings: ₹3,21,080 crore
- Outstanding stock: ₹47.63 lakh crore
- Shareholding: 6.74%
Combined Holdings
- Total FPI investment: ₹3,75,171 crore
- Total outstanding stock: ₹112.42 lakh crore
- Overall shareholding: 3.34%
Expected Impact
The proposed tax exemption is expected to strengthen India's appeal among global investors seeking exposure to sovereign debt instruments. By removing tax liabilities on both interest income and capital gains, the measure could encourage higher foreign inflows into Government Securities, improve market liquidity, and support the government's broader objective of deepening India's bond market.
With India's inclusion in major global bond indices already attracting international attention, the proposed tax relief could serve as another important catalyst for foreign investment in the country's debt ecosystem.
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