Foreign money exodus puts LTCG, STT on govt table: Can tax relief bring it back?

The question that had hung over Dalal Street for the past two weeks was, by the evening of October 27, edging from a conference stage towards the finance ministry’s calendar. The Union government may soon chair a consultation meeting with market participants on long-term capital gains (LTCG) tax and securities transaction tax (STT), according to reports citing government sources. It may not wait for the next Union Budget to respond to the foreign selling that has weighed on Indian markets all year.

The signals came with caveats. A review of the 12.5 per cent LTCG tax rate on equities is under discussion, but no decision has been taken or timeline set. The government is also reportedly examining a less familiar question: whether India’s struggle to attract AI investment is part of the reason foreign money is leaving.

The call for change is also coming from within the ruling BJP. “Capital markets reforms need recalibration in taxation, particularly STT and capital gains tax,” BJP leader and economist Gopal Krishna Agarwal told INDIA TODAY. “This reform is required urgently; otherwise the markets are in deep trouble.”

The events of the day had been building to it. Earlier on October 27, it emerged that the government had sought views on both levies from investors, market intermediaries and tax experts. A restructuring of LTCG tax was reportedly being considered, possibly including a cut from 12.5 per cent for domestic and foreign investors alike.

A government official was quoted as saying that the rate was being compared with those in major economies, and that a final decision would follow consultations already underway. The day before, an official had been quoted as saying that a decision on restructuring was “expected soon”. A more technical idea was also reportedly on the table: calculating foreign investors’ taxable gains in dollars rather than rupees.

The thread runs back to mid-October. On October 12, SBI Research proposed abolishing LTCG tax on equities and extending the holding period from one year to two or three years. The next day, at the Bloomberg New Economy Forum in New Delhi, finance minister Nirmala Sitharaman called the debate on LTCG tax and STT healthy and said she was keen to hear investors’ views.

Sitharaman acknowledged an argument often heard in market circles: that the two taxes overlap and only one should stay. But she committed to nothing, saying the Budget was too close for her to say what she would or would not consider. The finance ministry has made no formal announcement since.

Behind the urgency is a number. According to CDSL (Central Depository Services Limited) data, foreign portfolio investors (FPIs) have pulled about Rs 3.1 lakh crore out of Indian equities in 2026 so far. That is nearly double the Rs 1.7 lakh crore they withdrew in all of 2025. The Nifty is down about 13 per cent for the year. Officials are also said to be concerned about wider strains: two years of weak market returns, sluggish wage growth, more retail investors in the market, and doubts about whether domestic mutual fund inflows can keep absorbing the foreign selling.

The taxes in question are not new, but they have gone up. Long-term gains on listed shares held for more than a year are taxed at 12.5 per cent above Rs 1.25 lakh a year, with no indexation. With surcharge and cess, the effective rate is close to 15 per cent. The rate was 10 per cent until the July 2024 Budget. STT is charged on every trade, profitable or not, and Budget 2026 raised it on futures and options from April 1. Both taxes apply equally to domestic and foreign investors.

The case for relief starts with a comparison. Subject to conditions, foreign investors generally pay no capital gains tax on listed equities in the US, the UK, Singapore, Hong Kong, the UAE, Japan and Canada. Taiwan, which has drawn heavily on global funds this year, has no long-term capital gains tax. It levies a 0.3 per cent transaction tax instead. India charges both kinds of tax, which market participants have taken to calling double taxation.

Akhilesh Ranjan, a former member of the Central Board of Direct Taxes, makes the historical case. He has argued that STT was brought in partly to create an audit trail at a time when long-term gains went untaxed, and that there is no legitimate reason to keep it now that LTCG tax is back.

Sudhir Kapadia, senior advisor at KPMG, has suggested a different trade: exempt FPIs from capital gains tax and adjust STT to limit the revenue loss. Puneet Singhania, director at Master Capital Services, favours a phased approach—cutting STT first and easing LTCG tax later as the fiscal position allows.

The dollar-based idea addresses a narrower grievance. A foreign fund keeps its books in dollars but is taxed on gains in rupees. When the rupee weakens, the fund can owe tax on a gain that does not exist in its own currency. The Income Tax Act, 2025, already allows currency-conversion relief to non-residents selling shares of unlisted Indian companies, but not to FPIs holding listed equities.

There is a recent precedent too. From April 1 this year, the government exempted FPI investments in government securities from capital gains, interest and withholding tax. Supporters of relief cite it as proof that targeted exceptions are possible.

Those urging caution begin with the revenue. Equity LTCG tax brought in Rs 1.29 lakh crore in FY25, up from Rs 72,249 crore the year before. STT collections rose 52 per cent to Rs 46,840 crore between April 1 and October 14 at a time when the Centre is also paying for higher fertiliser subsidies and social sector spending.

Ranjan, for all his criticism of STT, draws the line at scrapping LTCG tax altogether. He has warned that exempting capital income just as AI erodes the tax base from labour would be a risky proposition.

There is also the question of fairness between investors. Officials are understood to be wary of taxing foreign and domestic investors differently because of the risk of round-tripping: Indian money routed abroad to return dressed as foreign. Not everyone accepts that India is an outlier either. PwC data shows foreign investors pay 20 per cent or more on capital gains in some emerging-market peers, including Brazil and Mexico. And as recently as August, the government told the Lok Sabha it had no proposal to review STT.

The sharpest doubt is about cause and effect. India’s equity tax rates have not changed this year, yet the outflows have nearly doubled. What has changed is how India’s market stacks up against the markets competing for the same money.

Global money has followed the AI rally into Taiwan and South Korea. The rupee has lost about 5.6 per cent against the dollar this year, and US Treasury yields have risen. Even after the fall, the Nifty trades at about 20.4 times earnings, above Japan’s 19.9.

Singhania, who backs an STT cut, says that when LTCG tax went up in 2024, some foreign funds trimmed their holdings, but valuations and global interest rates moved flows more. FPIs, he says, “care more about earnings growth, rupee stability and valuations”.

On the rupee, Agarwal says intervention by the Reserve Bank of India “may not be very effective” in this situation. “The RBI mandate does not attribute any level for the rupee,” he said. The central bank only manages volatility in the currency market.

What Sitharaman’s ministry decides may depend on which problem it sets out to solve. If the aim is to win back foreign capital, the narrower tools fit: dollar-based gains, relief limited to FPIs or an STT trade-off. Each costs relatively little, though relief aimed only at foreigners runs straight into the parity concern. If the aim is also to lift domestic sentiment, a broader rate cut comes into play. It would cost far more and since the first Rs 1.25 lakh of gains is already exempt, its benefit would grow with the size of an investor’s gains.

Then there is the question no tax change can settle. If foreign money is chasing AI stocks and avoiding a weak rupee, relief would raise post-tax returns without necessarily reversing the flow until those forces shift. Supporters treat tax as one lever among several. If costs and tax treatment influence investment decisions at all, reform could be part of a wider push to make India more competitive.

Agarwal, too, sees tax as only part of the answer. Trade depends on the strength of manufacturing, he says, and the government is using bilateral trade agreements to improve trade and supply chains. But for manufacturing, “there is no substitute to competitiveness”, and factor market reforms in land and capital, particularly the debt market, are “still work in progress”. For MSMEs, he argues, the reforms that could make a big difference are separating medium enterprises from micro and small ones, and separating trade and services from manufacturing.

Timing is the last choice. Acting before the Union Budget would show markets that the government is responding. Waiting for the Budget would leave room for the consultations already underway, which is when tax changes are usually made.

The coming weeks will show which way the government is leaning. Will the finance ministry formally convene the meeting, if so, whom will it invite? Does the dollar-based idea survive the parity debate? Does anything land before February 1, 2027 (Budget day)? Those answers will arrive alongside November’s FPI flow data and the rupee’s next move, which may say as much about what brings foreign money back as any tax change.