Some of the world's largest foreign portfolio investors (FPIs) have proposed a new capital gains tax structure for investments in Indian equities. Their suggestion is to introduce a third category called super long-term, under which investments held for more than three years would attract zero capital gains tax.
The proposal was reportedly discussed with senior Finance Ministry officials during recent meetings involving major foreign funds. It seeks to move beyond the existing two-tier system and offer lower tax rates to investors who stay invested in Indian equities for longer periods.
The suggestion comes as foreign investors have been pulling money out of Indian markets, raising concerns about sustained foreign investment flows.
How does the proposed three-tier tax structure work?
Currently, listed equity investments in India fall under two capital gains tax categories, depending on the holding period.
| Holding period | Existing tax treatment |
|---|---|
| Up to 12 months | Short-Term Capital Gains (STCG) tax of 20% |
| More than 12 months | Long-Term Capital Gains (LTCG) tax of 12.5%, subject to applicable conditions and exemptions |
Under the proposal, FPIs want the government to retain these two categories and add a third for investments held beyond three years.
The proposed structure would look something like this:
| Holding period | Proposed treatment |
|---|---|
| Up to 12 months | Existing STCG tax |
| 12 months to 3 years | Existing LTCG tax |
| More than 3 years | Zero capital gains tax |
The investors have also sought a rebate on Securities Transaction Tax (STT) for these longer-term investments. It is important to note that this is a proposal made by foreign investors. The government has not announced any such change.
Why are foreign investors seeking a tax break?
One of the key reasons behind this proposal is the continued selling by foreign investors in Indian equities. Since the beginning of 2025, FPIs have sold shares worth more than ₹4.6 lakh crore, according to depository data cited in the report.
Foreign investors have argued that the current tax structure does not sufficiently distinguish between investors who trade for shorter periods and those who commit capital for several years.
Pension funds and sovereign wealth funds, for instance, typically invest with longer horizons. A more favourable tax structure could improve their post-tax returns and make Indian equities more attractive compared with other investment destinations.
The proposal also draws on an earlier approach used in the debt market, where the government offered incentives to encourage long-term foreign investments.
Why do pension funds and sovereign wealth funds matter?
Pension funds and sovereign wealth funds are among the major sources of long-term institutional capital. According to data cited in the Moneycontrol report, India had 12,260 registered FPIs as of September 30, including 782 pension funds.
These 782 pension funds held assets worth approximately ₹7.33 lakh crore. Another 200 funds, majority-owned by pension funds or government organizations, held around ₹3.87 lakh crore. Sovereign wealth funds accounted for approximately ₹5 lakh crore. Together, these categories held assets worth around ₹16.2 lakh crore.
A tax exemption on investments held for more than three years could make Indian equities more attractive to these investors, encouraging them to maintain their exposure for longer periods.
Will this bring FIIs back to Indian markets?
A lower tax burden could improve the attractiveness of Indian equities for foreign investors, particularly those with longer investment horizons. It could also encourage more stable capital flows rather than investments driven by shorter-term opportunities.
However, taxation is only one of the factors influencing foreign investment decisions. Currency movements, global interest rates, valuations, corporate earnings, and the relative attractiveness of other markets also play a role in determining where foreign investors allocate their money.
There is also a question of whether such benefits should be extended only to foreign investors or made available to domestic investors as well. For the government, the challenge would be to balance the potential benefits of attracting long-term foreign capital against the revenue it could lose through tax exemptions.
For now, the proposal remains under discussion, and there is no confirmation that the government will introduce a third capital gains tax category.
Source: Moneycontrol
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