SEBI proposes scrapping LTCG tax on foreign investors, seeks relief for mutual fund investors

India's markets regulator, SEBI, has recommended the government remove the long-term capital gains (LTCG) tax on foreign investors, seeking relief for mutual fund investors. The regulator believes this move could help galvanize India's underperforming equity markets. SEBI has also suggested exempting domestic mutual fund investors from LTCG if they sell existing holdings to invest in new ones.

The recommendations, which come just months before the annual federal budget in February, are not binding and will rest with the government to make the final call. The move aims to reduce the upfront tax burden on foreign investors, as they have sold a record $31 billion in Indian stocks this year due to stagnant returns and the underperformance of the Indian equity market compared to its peers.

SEBI's proposals are part of its pre-budget representations and have been derived from multiple meetings held with foreign investors over the last two years. The regulator has observed that transaction costs associated with investing in Indian equities are among the highest globally. Currently, foreign investors pay a 12.5% LTCG tax on securities held for more than a year and a 20% short-term capital gains tax, along with securities transaction taxes and withholding taxes on dividends.

One of SEBI's key recommendations is to allow investors to switch between mutual fund schemes without incurring a taxable sale if they have held the units for more than a year. This move is aimed at encouraging investors to stay invested in domestic mutual funds, which have stagnated in returns over the past two years. Average returns from diversified domestic equity mutual funds are down 1.6%.