Centre grants tax exemption to Foreign Institutional Investors on capital gains in government securities

Why in News?

The Government of India has promulgated the Income-tax (Amendment) Ordinance, 2026, granting Foreign Portfolio Investors (FPIs)/Foreign Institutional Investors (FIIs) exemption from taxes on:

• Long-term capital gains (LTCG)
• Short-term capital gains (STCG)
• Withholding tax they must pay on their interest income

arising from investments in Government Securities (G-Secs). The exemption is applicable from 1 April 2026.

Key Provisions

• Earlier tax rates:
  • LTCG: 12.5%
  • STCG: 30%
  • Interest income: Around 20% withholding tax
• Under the new ordinance, these incomes will be fully exempt for foreign investors investing in Government Securities.

Objectives

• Attract long-term foreign capital.
• Increase participation of:
  • Pension funds
  • Insurance funds
  • Sovereign wealth funds
• Align India’s taxation framework with major global financial markets.
• Simplify market access and reduce operational complexities.

About Government Securities (G-Secs)

• Government Securities are debt instruments issued by the Government of India to finance fiscal requirements.
• Considered virtually risk-free as they carry sovereign backing.

Routes for Foreign Investment in G-Secs

1. General Route: Subject to investment limits prescribed by the Reserve Bank of India.

2. Fully Accessible Route (FAR)

• Introduced by RBI in 2020.
• Allows non-residents to invest in specified government securities without investment ceilings.
• Intended to facilitate greater global participation in India’s bond market.

Current Status

• Foreign investment in government bonds stands at about ₹3.75 lakh crore.
• This represents only 3.34% of the available investment space of ₹112.42 lakh crore under the General Route and FAR.

What is Withholding Tax?

• A tax deducted at source from payments made to non-residents.
• In this context, it is deducted from interest earned by foreign investors on government bonds.
• Before the amendment, non-residents paid approximately 20% withholding tax on such interest income.

Expected Impact

• Could attract an estimated $45–50 billion of foreign inflows over the next two years.
• Deepen India’s bond market.
• Lower government borrowing costs.
• Improve liquidity in Government Securities.
• Enhance India’s attractiveness as an investment destination.

Sources: AIR & ET