Potential Equity Capital Gains Tax Reduction Could Revive Foreign Portfolio Flows, Says Jefferies

A potential reduction in long- and short-term capital gains tax rates could encourage foreign portfolio investors (FPIs) to return to Indian equities following recent outflows, according to a report by global investment banking firm Jefferies. The move could also support the rupee, which has faced pressure from sustained capital outflows.

Market discussions have highlighted several possibilities, including an across-the-board reduction in long-term capital gains (LTCG) and short-term capital gains (STCG) tax rates, a targeted LTCG cut for FPIs, or allowing foreign investors to calculate gains in dollar terms to offset currency movements.

India abolished the LTCG tax on listed equities in 2004, introducing a 10 per cent STCG tax and a securities transaction tax (STT). The LTCG tax was reintroduced at 10 per cent in 2018 along with the STT. Since 2024, FPIs have been taxed at 12.5 per cent on long-term gains and 20 per cent on short-term gains, while tax advantages previously available through certain double-taxation avoidance agreements (DTAA) have narrowed since April 2019.

Equity LTCG tax collections stood at ₹1.3 lakh crore in fiscal year 2025 as domestic markets neared their peaks, while STT collections are annualising at about ₹85,000 crore in fiscal year 2027. Together, equity LTCG tax and STT accounted for approximately 8 per cent of direct tax collections and 5 per cent of gross tax revenue in fiscal year 2025. Consequently, the government will need to carefully weigh any potential revenue loss against the benefits of increased foreign investment.

Data indicates shifting foreign investor positioning. An analysis of 70 large emerging market funds with assets under management of $380 billion showed India underweight by 0.3 percentage points, compared to a 10-year average overweight of 2.2 percentage points. Equity-market-related exits by FPIs, foreign promoters, and foreign private equity investors have totaled $110 billion since April 2025. Meanwhile, following recent tax relief for foreign investors in government securities, debt FPI inflows reached $9 billion during June and July 2026.

Sector-wise, financials have recorded the largest net FPI outflows since October 2024 at $16 billion, followed by information technology and consumer staples at $10 billion each. If foreign flows recover, sectors such as banks, energy, utilities, and real estate could potentially benefit. Additionally, large-caps have underperformed by 5 percentage points in 2026 and currently trade at a 23 per cent discount to their 10-year average valuation, which may improve their relative appeal as earnings-growth differences narrow.

"Tax policy plays a critical role in shaping investor sentiment and capital allocation across emerging markets. While a reduction in capital gains tax could help reverse recent foreign outflows and support currency stability, policymakers face the complex task of managing fiscal constraints and revenue targets. For the broader business ecosystem, maintaining a competitive and predictable tax regime is essential for attracting sustained long-term investments into Indian equities and key growth sectors." — Dr. Shishir Gupta, Founder & CEO, StartupLanes