NEW DELHI: The Centre is undertaking a comprehensive relook at capital market taxation to boost investor sentiment, by considering options ranging from scrapping the securities transaction tax (STT) to offering tax concessions on interest income from corporate bonds to both domestic and foreign investors.
It is also examining proposals for a tiered long-term capital gains (LTCG) tax structure for equities, featuring lower rates for longer holding periods, and a possible exemption after a period such as three to five years. LTCG reliefs are, however, low on its priority. Currently, LTCG attracts a 12.5% tax for holdings of more than 12 months.
Broadly, three major options are under active consideration: providing relief exclusively to foreign portfolio investors (FPIs), extending it to all investors, or leaving equity untouched and focusing on debt markets, which have been adversely impacted, according to a source who requested anonymity. Discussions have been taking place over the past two months on the matter.
Although capital gains taxation in India has undergone many changes over decades, the policy appeared to stabilise with the reintroduction of LTCG tax on equities in 2018. The FY25 Budget raised tax rates on both short-term and long-term capital gains, introducing a flat 12.5% LTCG tax rate without indexation benefits. A carve-out was provided for small investors and moderate gains, with the exemption for profits up to `1.25 lakh.
While many commentators and market participants fiercely seek LTCG relief, it is not the government’s top priority. Such a move is seen as promoting inequity without a clear positive impact on foreign investment inflows, while also disturbing the taxation structure across asset classes. Another fallout of a lower LTCG tax rate is that investors might then tend to focus on high-growth stocks, ignoring high dividend-paying firms. This could make the revenue implications for the government even bigger as both LTCG tax and dividend tax receipts might take a hit. Dividend receipts are currently taxed in the hands of the shareholders as “income from other sources” at the respective slab rates.
Of direct taxes, the non-corporate segment has grown faster in recent years, partly because stock market taxes have become a highly elastic revenue source. From under `30,000 crore in FY20, capital gains tax revenue grew to `1.5 lakh crore in FY26.
On the other hand, since STT taxes equity transactions irrespective of profitability, burdening investors even during market losses, its removal or phasing out would reduce trading costs, the sources pointed out. Scrapping this transaction tax would also eliminate double taxation and improve market competitiveness, benefiting both foreign and domestic investors, including retail participants.
The government collected `46,840 crore in STT till October 14 this financial year, up 51.6% from the same period a year ago. In the Budget for FY27, STT collections are projected to rise 15.8% year-on-year to `73,700 crore.
Effective April 1, 2026, STT rates were at 0.1% on both sides of equity delivery, 0.025% on intra-day sales, 0.05% on futures sales, 0.15% on options premium and 0.15% on exercised options.
According to the sources, the thinking is clearly on the lines that the government should not be seen as only giving concessions to foreign investors. In an earlier round of tax changes related to capital market announced in June, capital gains and interest income were exempted for foreign investment in government securities, as part of the measures taken to boost capital inflows and support a battered rupee. Foreign investors got exempted from a 30% short-term capital gains tax, a 12.5% LTCG tax, and a 20% tax on interest income (treaty rates are even lower at 10%).
“Pressure is there to do something about taxes in the equity market. Either LTCG or STT should remain,” one of the three sources aware of the matter said, adding that the fiscal situation post-Covid was the reason the government could not remove one of these taxes. But now it can, despite headwinds expected from the 8th Pay Commission award next year, while it could draw comfort from a new mechanism to regulate the use of fertiliser to contain subsidies.
On the debt side, one proposal is to extend the existing G-Sec tax exemptions for foreign investors on capital gains and interest income to both foreign and domestic investors in corporate bonds. Alternatively, a concessional tax rate on interest income from corporate bonds is also being considered. Interest income from bonds is taxed at slab rates and can be as high as 30%.
No final decision has been taken yet on any of these proposals which might be announced in the forthcoming Budget, the sources clarified.
There is no immediate case for changing equity LTCG, as equity markets are functioning well and any reform must consider revenue implications, another source said. While targeted relief for FPIs or debt markets remains under consideration, any changes must follow a comprehensive, market-sensitive review rather than a piecemeal approach, the person added.
“STT was first introduced in 2004 as a revenue mobilisation measure as LTCG was not fetching enough revenue,” former Central Board of Direct Taxes (CBDT) member Arbind Modi said. He added that the STT should have been eliminated, once LTCG was reintrourced in 2018 and rates were hiked subsequenty.
“As markets were rising, a decision was taken in the 2018 Budget to set LTCG at 10%. CBDT advised that since we were introducing LTCG, STT should go away. But the government said it needed the money and brushed that advice aside. So, STT continued,” Modi said. He said both LTCG and dividend should be accorded symmetrical treatment. If LTCG is exempted, then tax on dividends should also be exempted. “Otherwise, if you tax dividends but do not tax LTCG, dividends will come down because companies will capitalise their earnings,” he argued.
Indian equities have higher valuations relative to other significant capital markets, while India’s corporate bond market is in need of much greater development in terms of breadth and depth, said Ajit Pai, strategy lead partner, EY GPS. “The government should use friendlier tax policies to encourage greater investment in bonds,” said Pai.
“FPI outflows have accelerated due to rising US interest rates and rather than chase those cyclical outflows across asset classes, India should focus on making Indian bonds a more attractive proposition without proportionate rise in yields that will slow issuance – this is possible through tax interventions,” Pai said, adding this would promote listing of bonds and attract greater retail participation in an otherwise private-place market now.
Sandeep Vempati, economist and a member of the Bharatiya Janata Party (BJP), said the immediate focus could instead be on easing compliance requirements for foreign investors. “The next year’s Budget is least likely to tweak rates for FPIs, as it would exert pressure on the fiscal side. The Budget is highly likely to address the concerns surrounding compliance,” he said.
Source: Business Standard
