In a decisive move to arrest the relentless exit of offshore capital and restore the competitive appeal of domestic equities, the Securities and Exchange Board of India has submitted significant tax relief proposals ahead of the upcoming Union Budget 2027 in February. The capital markets regulator has formally recommended abolishing the long-term capital gains tax levied on foreign investors. Alongside this offshore measure, the regulator has put forward a substantial concession for domestic retail mutual fund holders, suggesting complete exemption from capital gains tax when selling existing holdings held for more than a year to reallocate into new mutual fund schemes. The ultimate determination on whether to codify these regulatory recommendations into law rests entirely with the Finance Ministry headed by Nirmala Sitharaman.
Sustained Outflows Prompt Strong Regulatory Action
The regulatory intervention comes against the backdrop of sustained disinvestment by foreign portfolio entities, with foreign institutional investors remaining persistent net sellers in the domestic stock market across six consecutive calendar years. This relentless withdrawal has exerted continuous downward pressure on equity valuations and added headwinds to the domestic currency. Data compiled by Stock Edge reveals that cumulative net outflows by foreign institutional investors have surged to an unprecedented high of Rs 448,229.19 crore on a year-to-date basis. This follows back-to-back years in 2024 and 2025 where foreign institutional outflows comfortably surpassed Rs 3 lakh crore each year. The regulator formulated its proposals after conducting numerous consultations with foreign asset allocators over the preceding two years in an effort to identify key friction points hindering capital retention.
Tax-Free Reallocation Proposed for Domestic Mutual Fund Units
Complementing its foreign investor proposal, the regulator has targeted domestic retail investors who channel personal savings into diversified equity mutual funds. Returns across this segment have witnessed notable stagnation throughout the current period. Figures tracked by Morningstar indicate that average returns generated by mutual funds concentrated in large-cap equities retreated by 1.6 percent during this timeframe. Under prevailing norms, liquidating mutual fund units to switch schemes triggers an immediate tax event. The regulator has therefore suggested that domestic unitholders should be permitted to transfer capital from one mutual fund scheme into another without incurring tax liability, provided the underlying units have been held for longer than one year. Such a framework would allow retail savers to optimize portfolio asset allocation without facing a transaction-level tax penalty.
Scale of India's Domestic Mutual Fund Ecosystem
The proposed domestic relief arrives as the Indian mutual fund landscape commands an unprecedented volume of household financial savings. The domestic asset management industry currently oversees approximately Rs 82.6 lakh crore, equivalent to about 870.80 billion dollars, in total assets under management. Regular monthly contributions through systematic investment plans hover reliably between Rs 30,000 crore and Rs 32,000 crore. As of September 2026, the industry registers 10.06 crore active systematic investment plan accounts within a broader footprint of 28.62 crore total mutual fund folios. Cumulative assets managed directly through systematic investment plan routes now aggregate to Rs 17.86 lakh crore, highlighting how deeply retail wealth is anchored in market-linked vehicles.
Broader Financial Community Backs Capital Gains Reform
Industry research houses and financial brokerages have aligned behind calls to recalibrate transaction taxation. Global brokerage Jefferies pointed out that any prospective reduction in capital gains taxation would immediately bolster the relative attractiveness of domestic equities on the international stage, improving the trajectory of institutional inflows. Concurrently, brokerage house IIFL calculated that dismantling capital gains taxes could generate an effective expansion of roughly 2.3 percentage points in net returns realised by foreign investors. This margin enhancement could prove pivotal in swinging cross-border asset allocation models back toward domestic shores.
SBI Research Makes Case for Structural Policy Support
In an analytical assessment, State Bank of India emphasized the urgency of dismantling the long-term capital gains tax to revive offshore participation. SBI Research underscored that persistent capital flight reflects diminishing engagement by international allocators, a trend that demands structural policy remedy rather than administrative band-aids. In its formal note, the research team asserted that the government must evaluate anchoring volatile equity flows by stretching the recognized holding threshold to two to three years while entirely doing away with the long-term capital gains levy on equities.
The banking institution observed that routine foreign exchange and monetary interventions conducted by the Reserve Bank of India to calm broader financial volatility cannot replace core fiscal incentives. Structural fiscal adjustments from central authorities remain indispensable. SBI pointed out that erecting substantially low taxation barriers for institutional capital allocators after a reasonable holding commitment of three years could significantly accentuate incremental capital flows, particularly since the underlying investment thesis for domestic equities remains fundamentally sound and local marquee blue-chip corporations continue to deliver robust operational performance in a competitive global landscape.
Current Architecture of Capital Gains Levies
As the legal framework stands today, long-term capital gains taxation applies comprehensively across a wide basket of financial instruments, encompassing equities, debt securities, bonds, mutual fund units, gold, real estate investment trusts, and commodities. The levy also extends to capital assets within securities portfolios managed by foreign institutional investors operating under regulatory registrations, alongside real estate properties. By contrast, assets liquidated after a holding duration of less than 12 months incur a short-term capital gains tax rate of 20 percent.
According to administrative guidelines defined by the Income Tax Department, any capital asset retained by an assessee for a timeframe exceeding 36 months immediately preceding its date of legal transfer qualifies as a long-term capital asset, with the resulting appreciation recognized as long-term capital gains. Specific asset classes, such as listed equity shares and equity mutual funds, observe a shorter one-year threshold. With pre-budget consultations gearing up ahead of the presentation of Union Budget 2027, the financial community awaits the final determination of the Finance Ministry on whether to adopt these tax overhauls to stabilize markets and reward committed long-term wealth creators.
