The Securities and Exchange Board of India (SEBI) has reportedly recommended a major overhaul of the taxation framework for equity investments, proposing the removal of the 12.5% Long-Term Capital Gains (LTCG) tax on equity investments made by foreign investors. The market regulator has also suggested providing tax exemption on certain switches between domestic mutual fund schemes after an investment holding period of one year.
The recommendations assume significance at a time when Indian equity markets are witnessing substantial foreign investor outflows and struggling to match the performance of several other emerging markets. By seeking to reduce the tax burden on overseas investors and provide greater flexibility to domestic mutual fund investors, SEBI aims to make India's capital markets more attractive.
The proposals are expected to be considered by the Central Government as part of the pre-Budget exercise ahead of the Union Budget 2027, scheduled to be presented in February 2027. However, no changes have been approved so far and the existing capital gains tax provisions continue to apply.
SEBI Recommends Removal of 12.5% LTCG Tax on Foreign Investors
One of the most significant recommendations made by SEBI is the proposed removal of the 12.5% long-term capital gains tax applicable to foreign investors on eligible equity investments.
Under the existing income tax framework, long-term capital gains arising from the transfer of listed equity shares and specified equity-oriented investments are generally taxable at 12.5% under Section 112A of the Income-tax Act, 1961, subject to the applicable annual exemption threshold and other prescribed conditions.
For eligible equity investments held for more than 12 months, the proposed exemption could improve the post-tax returns of foreign portfolio investors (FPIs) and make Indian equities more competitive with investment destinations offering comparatively favourable tax treatment.
The recommendation comes against the backdrop of significant foreign portfolio investment outflows from Indian markets. Foreign investors have reportedly sold approximately $31 billion worth of Indian equities in 2026, raising concerns about India's ability to attract and retain overseas investment.
SEBI believes that revisiting the capital gains tax structure could help address some of these concerns and improve foreign investor participation in the domestic equity market.
Mutual Fund Investors May Get Tax Exemption on Scheme Switching
SEBI has reportedly proposed another important tax relief measure for domestic investors, particularly those investing through mutual funds.
Currently, switching investments from one mutual fund scheme to another is generally treated as a taxable transfer. This means that even if an investor does not withdraw money from the mutual fund industry but simply moves the investment from one scheme to another, capital gains tax may arise.
For example, if an investor switches units from one equity mutual fund scheme to another after holding the original investment for more than 12 months, the transaction is generally treated as a redemption from the original scheme. Any eligible long-term capital gains arising from that redemption may attract tax under the applicable provisions.
SEBI has reportedly recommended exempting qualifying switches made after a holding period of one year from LTCG tax.
If accepted, the proposal could allow investors to rebalance their mutual fund portfolios, change investment strategies and move between eligible schemes without an immediate capital gains tax liability.
This could be particularly beneficial for long-term investors who regularly review their portfolios and shift investments based on changing financial goals or market conditions.
Why Has SEBI Proposed Changes to Equity Capital Gains Tax?
The recommendations come amid growing concerns over foreign investor participation in Indian equity markets.
Several factors have reportedly influenced SEBI's push for a review of the existing tax framework:
1. Significant Foreign Investor Outflows
Foreign portfolio investors have reportedly withdrawn substantial amounts from Indian equities during 2026. Such persistent selling has raised concerns about market liquidity, investor confidence and the availability of overseas capital.
2. Underperformance Compared with Emerging Markets
Indian equity markets have faced challenges in delivering returns comparable to several other emerging economies. Differences in market performance have influenced the allocation decisions of global investors.
3. High Transaction and Investment Costs
The overall cost of investing in Indian equities, including taxes and transaction-related charges, has been a concern for foreign investors. SEBI has reportedly highlighted the need to make the Indian market more cost-efficient.
4. Improving India's Global Investment Competitiveness
With international investors evaluating multiple markets before allocating capital, a more competitive tax structure could help India attract a greater share of global investment.
SEBI's recommendations are therefore aimed at addressing both taxation-related concerns and the broader attractiveness of Indian equity markets.
Finance Minister Nirmala Sitharaman Signals Openness to Reviewing Equity Taxation
The proposed changes have also attracted attention following recent remarks by Finance Minister Nirmala Sitharaman.
The Finance Minister has acknowledged that market conditions and investor circumstances have changed, indicating that the concerns surrounding foreign investment and equity taxation deserve consideration.
Her remarks have fuelled expectations of a possible review of the existing LTCG and Securities Transaction Tax (STT) framework ahead of Budget 2027.
However, no formal announcement has been made regarding the withdrawal of LTCG tax or a reduction in STT. Any such change would require a formal government decision and the necessary legislative or regulatory action.
Government Faces Revenue Concerns as LTCG Collections Reach ₹1.29 Lakh Crore
Although SEBI's recommendations could improve India's investment attractiveness, removing LTCG tax would also have implications for government revenue.
Capital gains taxation has emerged as a significant source of tax collections following the changes introduced in the Union Budget 2024.
The government reportedly collected approximately ₹1.29 lakh crore through LTCG tax in FY 2024-25, compared with around ₹72,249 crore in FY 2023-24.
This substantial increase makes the proposed exemption an important fiscal consideration.
The government will need to evaluate whether the potential benefits of increased foreign investment, higher market participation and improved investor confidence would justify the revenue impact of such a tax concession.
Domestic Investors Raise Questions Over Differential Tax Treatment
SEBI's proposal to remove LTCG tax for foreign investors has also triggered debate among domestic retail investors.
Indian investors have consistently supported the equity market through direct investments and systematic investment plans (SIPs), even during periods of volatility. Many retail investors believe that domestic participation has played an important role in providing stability to the Indian markets when foreign investors have been net sellers.
Against this backdrop, a complete LTCG exemption for foreign investors could raise questions about whether domestic and overseas investors are being treated equitably.
While the proposed exemption on mutual fund scheme switches could benefit domestic investors, it would not necessarily provide the same relief as a broader exemption from LTCG tax.
The government will therefore have to consider the interests of both investor groups while evaluating SEBI's recommendations.
Will the LTCG Tax Be Removed in Budget 2027?
SEBI's recommendations are part of the policy discussions ahead of the Union Budget 2027. However, a recommendation by the market regulator does not automatically result in a change in the Income-tax Act.
The Finance Ministry will examine the proposals along with their potential impact on foreign investment, domestic investors and government revenue.
If the government accepts the recommendations, appropriate amendments may be proposed in the Finance Bill 2027 or through other applicable legal mechanisms.
Until then, the existing provisions under Section 112A of the Income-tax Act, 1961, will continue to govern eligible long-term capital gains from equity investments.
Conclusion
SEBI's proposal to abolish the 12.5% LTCG tax for foreign investors and provide tax relief on qualifying mutual fund switches could become one of the important taxation issues ahead of Union Budget 2027.
The recommendations reflect the regulator's concerns over foreign investor outflows, India's relative market performance and the need to improve the competitiveness of domestic capital markets.
However, the proposals also raise important questions about government revenue and the treatment of domestic investors who continue to contribute to equity markets through SIPs and direct investments.
Whether the Finance Ministry accepts these recommendations will be closely watched by foreign portfolio investors, mutual fund investors and the wider financial market.
Important: These are reported recommendations and not approved tax changes. The existing capital gains tax provisions will remain applicable until the government officially announces any amendment.
CAclubindia
