India Exempts Foreign Investors from Capital Gains Tax on Government Bonds

In a significant move to bolster its economy, attract foreign capital, and strengthen the Indian rupee, the Government of India has exempted Foreign Portfolio Investors (FPIs) from both capital gains tax and income tax on interest earned from investments in government securities (G-Secs). This crucial policy change was implemented through the promulgation of an Income-tax (Amendment) Ordinance, 2026, on Friday, June 5, 2026, following approval by the Union Cabinet. The exemption has been made effective retrospectively from April 1, 2026, signifying the government's intent to provide immediate and comprehensive relief to foreign investors. The decision comes amidst a period of considerable pressure on the Indian rupee, which has experienced depreciation, partly due to significant outflows of foreign funds from equity markets and global geopolitical uncertainties, including the ongoing Iran conflict leading to elevated crude oil prices. Foreign institutional investors have reportedly withdrawn substantial amounts from Indian equities, making it imperative for the government to introduce measures that enhance India's attractiveness as an investment destination. Under the previous tax regime, foreign investors were subjected to a 12.5% long-term capital gains tax on listed equities and bonds held for over 12 months. Furthermore, interest earned on government securities attracted a 20% withholding tax. A concessional 5% tax rate that was available to foreign investors for certain periods was withdrawn in 2023, making Indian debt markets less competitive compared to many other jurisdictions. The current exemption aims to rectify this, aligning India's taxation framework for G-Secs with global standards and thereby improving post-tax returns for FPIs. Beyond just the tax exemptions, the government, in conjunction with the Reserve Bank of India (RBI), has introduced several other complementary measures to deepen the Indian debt market and facilitate greater foreign participation. The RBI announced an expansion of the Fully Accessible Route (FAR) framework, which allows non-residents to invest in specific government securities without quantitative restrictions. This expansion now includes new issuances in government securities with longer tenors of 15, 30, and 40 years, as well as Sovereign Green Bonds. Additionally, restrictions such as caps on investment, concentration limits, and security-wise limits on FPI investments through the General Route have been removed, although overall quantitative investment limits remain. These steps are designed to broaden the investor base for Indian government securities, encouraging wider participation from global investors, including long-term institutional investors like pension funds and sovereign wealth funds. Experts and market analysts have largely welcomed these reforms, viewing them as crucial for attracting durable and stable foreign capital inflows. The expectation is that these measures will not only provide much-needed support to the rupee by boosting foreign exchange inflows but also enhance the liquidity and depth of India's bond markets. By making investments in G-Secs more attractive, India aims to improve its integration into global bond indices, potentially leading to even larger inflows in the future. The exemption also applies to the Bank for International Settlements (BIS) for its investments in G-Secs, further emphasizing the broad scope of this policy. The timing of this policy is significant, given the substantial foreign fund outflows observed in the current calendar year. While the rupee has seen some recovery recently due to RBI intervention and easing crude oil prices, the sustained pressure necessitated comprehensive policy interventions. The government's proactive approach, through an ordinance, underscores the urgency of addressing these economic challenges and reinforcing investor confidence in the Indian market. The measures are expected to contribute significantly to financing India's current account deficit and stabilizing its balance of payments. In essence, India's decision to remove capital gains tax and interest income tax for foreign investors in government bonds, coupled with other liberalization measures, represents a strategic effort to enhance its economic resilience, attract crucial foreign investment, and solidify its position in the global financial landscape. This comprehensive approach is anticipated to yield positive outcomes for the Indian economy, its currency, and its capital markets in the medium to long term.

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