{"id":375362,"date":"2026-11-10T17:58:50","date_gmt":"2026-11-10T12:28:50","guid":{"rendered":"https:\/\/forumias.com\/blog\/?p=375362"},"modified":"2026-11-10T17:58:50","modified_gmt":"2026-11-10T12:28:50","slug":"a-tax-fix-that-can-attract-more-foreign-capital","status":"publish","type":"post","link":"https:\/\/forumias.com\/blog\/a-tax-fix-that-can-attract-more-foreign-capital\/","title":{"rendered":"A Tax Fix That Can Attract More Foreign Capital"},"content":{"rendered":"

UPSC Syllabus: Gs Paper 3- <\/strong>Indian Economy<\/p>\n

Introduction<\/strong><\/h2>\n

India is facing sustained foreign capital outflows from its equity markets, while its corporate debt market also needs deeper domestic and foreign participation. With the interest-rate gap between India and the US near historic lows<\/strong>, raising domestic rates to support the rupee could increase borrowing costs and weaken corporate earnings. Tax reforms offer an alternative<\/strong> by improving post-tax returns and strengthening market liquidity.<\/p>\n

Why Is Foreign Capital Leaving Indian Markets?<\/strong><\/h2>\n
    \n
  1. Declining foreign investment: <\/strong>Foreign investors’ holdings in Indian stocks have reached an all-time low of 14%<\/strong>, reflecting weaker interest in Indian equities.<\/li>\n
  2. Large capital outflows: <\/strong>Foreign investors withdrew a net $18.9 billion<\/strong> in 2025 and more than $30 billion<\/strong> so far in 2026, indicating sustained withdrawals.<\/li>\n
  3. Poor market performance: <\/strong>India ranked the third worst-performing market<\/strong> after Indonesia and Turkey between January and October 2026. The Nifty 50 had declined nearly 9%.<\/li>\n
  4. Expensive market valuations: <\/strong>India’s rolling 12-month forward price-to-earnings (P\/E) ratio stood at 18.6<\/strong>, above Taiwan’s 16.8<\/strong> and Korea’s 3.9<\/strong>, making alternative markets relatively cheaper.<\/li>\n
  5. Disappointing earnings growth: <\/strong>India’s forecast earnings growth is 11%<\/strong>, against the emerging-market average of 45%<\/strong>, weakening the justification for its higher market valuations.<\/li>\n
  6. Rising investment risks: <\/strong>Strained US ties, higher energy prices, rupee depreciation, geopolitical tensions and uncertainty over artificial intelligence have increased perceived investment risks.<\/li>\n
  7. Changing relative returns: <\/strong>Foreign investors invested \u20b9570 billion<\/strong> in September 2024, but withdrew \u20b9940 billion<\/strong> in October to pursue cheaper Chinese stocks, despite unchanged Indian tax rates.<\/li>\n<\/ol>\n

    Tax-Related Barriers to Foreign Investment in India<\/strong><\/h2>\n
      \n
    1. Higher LTCG tax burden: <\/strong>The long-term capital gains (LTCG) tax was increased in 2024, prompting the market regulator and PHD Chamber of Commerce and Industry to demand its removal for foreign portfolio investors (FPIs).<\/li>\n
    2. Uncertain treaty benefits: <\/strong>The Principal Purpose Test under the India-Mauritius Double Taxation Avoidance Agreement (DTAA) allows authorities to deny treaty benefits when obtaining those benefits is one of the principal purposes of an arrangement.<\/li>\n
    3. Limited India-US tax exemption: <\/strong>Article 13 of the India-US DTAA allows both countries to tax capital gains under domestic law, while Article 25 provides relief from double taxation, subject to US tax rules.<\/li>\n
    4. Rupee-based capital gains calculation: <\/strong>India calculates capital gains in rupees, so depreciation can create taxable gains even when foreign investors sell their investments at unchanged dollar values.<\/li>\n
    5. Lower post-tax returns: <\/strong>High taxes reduce the attractiveness of Indian debt investments when global funds compare post-tax returns across different investment markets.<\/li>\n<\/ol>\n

      Need for Tax Parity Between Debt and Equity Investments<\/strong><\/h2>\n
        \n
      1. Unequal tax treatment of debt and equity funds: <\/strong>Equity funds face 12.5%<\/strong> tax on long-term gains and 20%<\/strong> on short-term gains, while specified debt-fund gains are taxed at marginal rates, reaching 30%<\/strong> for the highest tax bracket before cess and surcharge.<\/li>\n
      2. Need for greater domestic participation: <\/strong>Favourable debt-fund taxation can increase domestic investment and assets under management (AUM), expanding the investor base and improving corporate bond market depth.<\/li>\n
      3. Importance of pooled investment vehicles: <\/strong>Debt mutual funds and corporate bond Exchange-Traded Funds (ETFs) provide diversified exposure, avoiding the difficulty of purchasing and holding individual corporate bonds.<\/li>\n<\/ol>\n

        Proposed Tax Reforms to Attract Foreign Capital<\/strong><\/h2>\n
          \n
        1. Review foreign equity LTCG: <\/strong>The market regulator and PHD Chamber have urged the removal of LTCG tax for foreign investors, while the Finance Minister has agreed to consider the demand.<\/li>\n
        2. Rationalise debt-fund taxation: <\/strong>Bringing debt-fund tax treatment closer to equity funds could reduce the existing disadvantage and encourage greater domestic investment.<\/li>\n
        3. Reduce tax on foreign debt investments: <\/strong>Lower taxation on debt gains can improve post-tax returns and reduce the disadvantage arising from rupee depreciation when foreign investors calculate returns in their home currencies.<\/li>\n
        4. Extend government-security tax incentives: <\/strong>Eligible foreign investors already receive income-tax exemptions on interest and capital gains from government securities. Extending similar incentives to corporate debt could attract foreign investment and deepen the market.<\/li>\n<\/ol>\n

          How Can Tax Reforms Strengthen India’s Financial Markets?<\/strong><\/h2>\n
            \n
          1. Support foreign exchange inflows: <\/strong>Greater foreign investment can increase foreign exchange inflows and support rupee stability, reducing excessive dependence on scarce foreign exchange reserves.<\/li>\n
          2. Improve corporate bond liquidity: <\/strong>Greater domestic participation can expand the investor base, strengthen trading activity and improve liquidity in the corporate bond market.<\/li>\n
          3. Facilitate large-volume transactions: <\/strong>A deeper market allows foreign investors to trade substantial volumes without causing sharp price movements or incurring substantial losses.<\/li>\n
          4. Reduce pressure for interest-rate hikes: <\/strong>Tax reforms offer an alternative to raising domestic interest rates, which increase borrowing costs, squeeze corporate profit margins and weaken earnings growth.<\/li>\n<\/ol>\n

            Limitations of Tax Cuts and the Need for Broader Reforms<\/strong><\/h2>\n
              \n
            1. Revenue loss for the government: <\/strong>Tax reductions would lower government revenue, making the Finance Minister cautious about removing or reducing capital gains taxes.<\/li>\n
            2. Importance of strong economic fundamentals: <\/strong>Tax cuts alone cannot reverse capital outflows. Investors also need predictable earnings growth and reasonable valuations to justify India’s premium over competing markets.<\/li>\n
            3. Persistent geopolitical and technological risks: <\/strong>Geopolitical tensions and uncertainty surrounding artificial intelligence can continue to weaken long-term growth expectations, even after improvements in tax rules.<\/li>\n
            4. Limited impact of temporary market support: <\/strong>Lower global bond yields and expectations of rupee support through central bank intervention may improve market sentiment, but cannot resolve structural investment concerns.<\/li>\n<\/ol>\n

              Conclusion<\/strong><\/p>\n

              India needs a competitive tax regime for both equity and debt investments. Reviewing LTCG taxation and reducing the disadvantage faced by debt funds<\/strong> could improve post-tax returns, deepen corporate bond markets and support foreign exchange inflows. However, sustained investment will also depend on stronger earnings, reasonable valuations and lower economic uncertainty.<\/strong><\/p>\n

              Question for practice:<\/strong><\/p>\n

              Discuss how tax reforms can help attract foreign capital, strengthen India’s financial markets and address the challenges of declining foreign investment.<\/p>\n

              Source: <\/strong>Businessline<\/strong><\/a><\/p>\n","protected":false},"excerpt":{"rendered":"

              UPSC Syllabus: Gs Paper 3- Indian Economy Introduction India is facing sustained foreign capital outflows from its equity markets, while its corporate debt market also needs deeper domestic and foreign participation. With the interest-rate gap between India and the US near historic lows, raising domestic rates to support the rupee could increase borrowing costs and… Continue reading A Tax Fix That Can Attract More Foreign Capital<\/span><\/a><\/p>\n","protected":false},"author":10320,"featured_media":0,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"jetpack_post_was_ever_published":false,"footnotes":""},"categories":[1230],"tags":[12044,216,8184],"class_list":["post-375362","post","type-post","status-publish","format-standard","hentry","category-9-pm-daily-articles","tag-business-line","tag-gs-paper-3","tag-indian-economy","entry"],"jetpack_featured_media_url":"","views":"","jetpack_sharing_enabled":true,"_links":{"self":[{"href":"https:\/\/forumias.com\/blog\/wp-json\/wp\/v2\/posts\/375362","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/forumias.com\/blog\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/forumias.com\/blog\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/forumias.com\/blog\/wp-json\/wp\/v2\/users\/10320"}],"replies":[{"embeddable":true,"href":"https:\/\/forumias.com\/blog\/wp-json\/wp\/v2\/comments?post=375362"}],"version-history":[{"count":0,"href":"https:\/\/forumias.com\/blog\/wp-json\/wp\/v2\/posts\/375362\/revisions"}],"wp:attachment":[{"href":"https:\/\/forumias.com\/blog\/wp-json\/wp\/v2\/media?parent=375362"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/forumias.com\/blog\/wp-json\/wp\/v2\/categories?post=375362"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/forumias.com\/blog\/wp-json\/wp\/v2\/tags?post=375362"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}