India’s Capital Gains Tax

India’s recent decision to impose a capital gains tax on foreign investors has ignited debate. Market expert Samir Arora has labelled this move as the government’s “biggest mistake.” His comments at the Business Standard Manthan Summit 2025 highlight the potential adverse effects on foreign institutional investors (FIIs) and the Indian market.

About Capital Gains Tax

Capital gains tax is levied on the profit made from selling capital assets. These assets include stocks, mutual funds, property, and gold. The tax classification depends on the holding period. If an asset is held for over a year, the profit is considered a long-term capital gain (LTCG). If held for less than a year, it is a short-term capital gain (STCG).

Types of Capital Gains Tax

There are two main categories:

• Short-Term Capital Gains (STCG) – This applies to assets sold within a short duration. In India, STCG on equity investments is taxed at 15%.
• Long-Term Capital Gains (LTCG) – This applies to assets held longer. LTCG on stocks is taxed at 12.5% for profits exceeding Rs 1.25 lakh per year.

Calculating STCG and LTCG

STCG is calculated by subtracting acquisition costs and sale-related expenses from the selling price. The formula is: STCG = Sale Price
(Purchase Price + Improvement Cost + Transfer Expenses). For LTCG, the taxable amount is determined similarly but may include deductions for certain transaction costs.

Recent Changes and Investor Reactions

The Union Budget 2024-25 introduced changes. The LTCG tax rate increased from 10% to 12.5%, and the indexation benefit was removed. This has raised concerns among investors, particularly foreign ones, as it increases their tax burden and discourages investment in India.

Impact on Foreign Investment

Since October 2024, foreign investors have withdrawn over Rs 2 trillion from Indian equities. Factors contributing to this trend include higher capital gains taxes, weak corporate earnings, a depreciating rupee, and more attractive investment options in stronger US markets.

International Comparison of Capital Gains Tax

India’s capital gains tax structure is relatively high compared to other countries. For example:

• In Australia, 50% of capital gains are taxable after a year.
• Canada taxes 50% of capital gains, increasing for higher amounts.
• The United States employs a progressive tax system with rates based on income.
• The UAE has no capital gains tax, making it attractive for investors.

Questions for UPSC:

1. Critically discuss the implications of capital gains tax on foreign investment in India.
2. Examine the role of capital gains tax in shaping investment strategies for foreign institutional investors.
3. Analyse the impact of the recent capital gains tax changes on the Indian equity market.
4. Estimate the long-term effects of capital gains tax policies on India’s economic growth and investor confidence.

Answer Hints:

1. Critically discuss the implications of capital gains tax on foreign investment in India.

1. Capital gains tax increases the cost of investment for foreign investors.
2. Higher tax rates and the removal of indexation benefits disincentivize long-term investments.
3. Foreign investors have withdrawn funds, indicating decreased confidence.
4. Tax policies may lead to a shift towards markets with more favorable tax regimes.
5. Long-term implications include potential stagnation in foreign direct investment (FDI) inflows.

2. Examine the role of capital gains tax in shaping investment strategies for foreign institutional investors.

1. Tax considerations influence asset allocation and investment horizons for FIIs.
2. Higher taxes may prompt FIIs to seek tax-efficient investment structures or alternatives.
3. Foreign investors may prioritize markets with lower tax burdens for better returns.
4. Investment strategies may shift towards short-term trading to mitigate tax liabilities.
5. FIIs may also diversify portfolios to hedge against unfavorable tax impacts in India.

3. Analyse the impact of the recent capital gains tax changes on the Indian equity market.

1. Post-tax changes, foreign investors have pulled out over Rs 2 trillion from equities.
2. Higher tax rates have made Indian markets less attractive compared to global peers.
3. Investor sentiment has soured, leading to reduced market liquidity and volatility.
4. Weak corporate earnings further exacerbate investor apprehension and market decline.
5. Long-term growth prospects for the Indian equity market may be adversely affected.

4. Estimate the long-term effects of capital gains tax policies on India’s economic growth and investor confidence.

1. Increased tax burdens could lead to reduced foreign investment, hampering economic growth.
2. Investor confidence may wane, affecting capital inflows and market stability.
3. Long-term capital gains tax policies could deter startups and innovation due to funding challenges.
4. Economic growth may slow if foreign investors shift focus to more favorable markets.
5. Persistent negative sentiment could lead to structural changes in the Indian investment landscape.