The discourse surrounding the taxation of long-term capital gains (LTCG) has moved to the forefront of India’s economic policy discussions. As the domestic equity market navigates a period of volatility and significant outflows from foreign institutional investors (FIIs), the State Bank of India (SBI) has put forward a compelling case for re-evaluating the current tax framework. By analyzing the potential for structural reform, the report highlights a pathway that could bolster market participation without compromising the government’s fiscal consolidation objectives.
The Changing Landscape of Indian Equity Markets
The fiscal year 2025 has presented a challenging environment for the Indian stock market, marked by a sharp departure from the robust performance observed in previous cycles. After witnessing a period where equity markets generated significant double-digit returns, the narrative has shifted toward a more sobering reality. Data indicates that the average return for the Nifty index over the past three years has hovered at a modest 0.5 percent. This cooling in performance has coincided with a substantial withdrawal of capital by foreign institutional investors, who have pulled roughly Rs 4.8 lakh crore from domestic markets.
This trend is not merely a reflection of global economic headwinds but also a signal that the cost of investment in India is being weighed heavily by international and domestic participants. The current tax regime, which imposes a 12.5 percent levy on long-term capital gains, is increasingly viewed as an impediment to long-term wealth creation. When market returns are compressed, the effective tax burden becomes a significant drag on net yields, prompting investors to reallocate capital toward more attractive jurisdictions.
Evaluating the Fiscal Feasibility of Abolition
A common concern regarding the removal of the LTCG tax is the immediate impact on the national exchequer. However, the SBI research provides a balanced perspective, suggesting that the government could absorb this change without deviating from its established fiscal glide path. The projected revenue loss from abolishing the LTCG tax is estimated at approximately Rs 40,000 to Rs 50,000 crore for the 2028 fiscal year.
In the context of the broader economy, this shortfall represents only 0.1 to 0.2 percent of India’s GDP. The report argues that the high collections recorded in FY25, which totaled Rs 1.3 lakh crore, were an anomaly fueled by exceptional market performance rather than a sustainable baseline for government revenue. By framing the fiscal impact in these terms, policymakers can view the potential abolition not as a loss of essential revenue, but as a strategic investment in market liquidity and investor sentiment.
Mechanisms for Gradual Reform and Restructuring
The SBI report proposes several innovative strategies that could replace a flat tax structure with more nuanced alternatives. One such proposal involves linking the tax exemption threshold to inflation. Currently set at Rs 1.25 lakh, this limit fails to account for the erosion of purchasing power over time. By indexing this threshold, the government can protect retail investors from tax inflation and provide a more equitable environment for small-scale wealth accumulation.
Another significant proposal involves a tiered tax system based on the duration of holding. By rewarding long-term patience, the government could reduce the LTCG tax to zero for assets held for more than three years. This would serve as a powerful incentive for investors to transition from short-term trading to long-term value creation. Furthermore, the report suggests adopting a reinvestment model similar to the provisions for property sales. Under this mechanism, investors could defer tax payments on mutual fund redemptions if they move their capital into other eligible equity funds within a defined 90-day window. This would facilitate better portfolio management and encourage the recycling of capital within the domestic market.
The Role of Securities Transaction Tax
While the abolition of LTCG tax is a central proposal, the fiscal balance could be maintained through adjustments to the Securities Transaction Tax (STT). Currently, STT collections are a stable source of revenue, estimated at Rs 73,000 crore for FY27. SBI suggests that a moderate increase in STT—potentially by 50 percent—could generate approximately Rs 45,000 crore in additional revenue.
This trade-off has significant implications for market behavior. Unlike the capital gains tax, which is levied on profits and can discourage the booking of gains, STT is a transactional cost. By shifting the burden toward market turnover, the government can ensure a steady stream of revenue that is linked to the activity level of the exchanges. If the removal of LTCG tax successfully boosts volumes and market liquidity, the resulting surge in transaction activity would likely compensate for the higher STT rate, creating a self-sustaining revenue model that benefits both the state and the participants.
Strategic Implications for Global Competitiveness
The overarching goal of these reforms is to ensure that India remains a competitive destination for both domestic and global capital. The current tax environment is frequently cited by institutional investors as a factor in their decision-making process. By creating a more favorable tax climate, India can mitigate the recent trend of consistent FPI withdrawals and restore confidence in the resilience of its equity markets.
The emphasis on long-term commitment is particularly critical. In many mature markets, capital gains taxes are structured to encourage long-term holdings, which in turn reduces market volatility and provides stability to corporate India. By aligning India’s tax structure with international best practices, the government can signal to the global investment community that it is committed to fostering a stable, investor-friendly ecosystem.
As India moves toward its goal of becoming a five-trillion-dollar economy, the vitality of its capital markets will remain a cornerstone of national development. The proposals outlined by the SBI research offer a pragmatic roadmap for transition. By focusing on the expansion of the retail investor base, incentivizing long-term asset ownership, and ensuring fiscal stability through balanced adjustments, the government has the capacity to transform the regulatory environment in a manner that serves the long-term interests of the Indian economy. The conversation around the abolition of LTCG is therefore not just a technical debate on tax policy, but a strategic imperative for the next phase of India’s market evolution.
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