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India’s recent decision to impose a capital gains tax on foreign investors has sparked significant debate. Market analysts, including Samir Arora, have criticized this move, labeling it a major error by the government. This tax is expected to discourage foreign institutional investors (FIIs), which could lead to a reduction in foreign investments in Indian financial markets.

About Capital Gains Tax

Capital gains tax is charged on the profits earned from selling capital assets. These assets may include stocks, mutual funds, real estate, and precious metals like gold. When such assets are sold, the profit made is classified as a capital gain and is subject to tax.

Types Of Capital Gains Tax

Capital gains tax is divided into two main categories:

• Short-term Capital Gains (STCG) - This tax applies when assets are sold within a short period, typically at a higher tax rate.

• Long-term Capital Gains (LTCG) - This tax applies when assets are held for a longer duration, generally taxed at a lower rate to incentivize long-term investments.

Short-Term Capital Gains (STCG) In India

In India, STCG is levied when assets like stocks and real estate are sold within a specified holding period. For stocks, this period is usually less than one year, and for real estate, it is less than two years. The tax rate for STCG on equity investments is 15%, while other assets are taxed according to the individual's applicable income tax bracket.

Calculating STCG

STCG is calculated by subtracting the cost of acquisition and any associated expenses from the sale price. The formula is:

STCG = Sale Price – (Purchase Price + Improvement Costs + Transfer Expenses).

Long-Term Capital Gains (LTCG) In India

LTCG on equity investments such as stocks and mutual funds is taxed at 12.5% for profits exceeding Rupees 1.25 lakh per year. The Union Budget 2024-25 raised the LTCG tax rate and removed the indexation benefit, which previously allowed adjustments for inflation in calculating the purchase price.

Calculating LTCG

LTCG is determined by subtracting the purchase price of an asset from the sale price. For high-value assets, certain transaction costs can also be deducted.

Concerns From Investors

The removal of the indexation benefit has been met with concerns, particularly among investors selling properties and unlisted assets. This change increases their tax burden. Foreign investors are especially impacted as they do not have tax relief options in their home countries.

Impact On Indian Markets

Since October 2024, foreign investors have pulled out more than Rupees 2 trillion from Indian equities. This trend is driven by several factors, including the hike in capital gains taxes, lackluster corporate earnings, a depreciating rupee, and stronger returns from US markets, which are attracting investment away from India.

Comparative Capital Gains Taxation

India’s capital gains tax structure differs from that of other nations. For example, Australia taxes 50% of capital gains, while the United States uses a progressive tax system based on income. On the other hand, countries like the United Arab Emirates impose no capital gains tax at all, making them more attractive to international investors.

The government's decision to raise capital gains taxes has triggered concerns among investors, particularly foreign ones, who could be discouraged from investing in Indian markets.

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