Capital Gains Tax Explained: Why Dollar Returns Matter for Foreign Investors

Reported proposals: The Indian Express reports discussions before Union Budget 2027–28 about reducing long-term capital gains tax and allowing foreign investors' gains to be assessed in dollar terms.

Status: A discussion reported by a newspaper is not an enacted tax concession. The report does not establish an approved replacement rate or a final currency-computation mechanism.

Legal principle: Article 265 of the Constitution requires authority of law for taxation. Changes must follow the applicable legislative or lawfully delegated process, with clear commencement provisions.

Basic concept: A capital gain is generally a profit arising from transfer of a capital asset, such as shares held as an investment. Taxable gain is computed after deductions and adjustments permitted by law.

Simple illustration: If an investment is bought for Rs 1 lakh and sold for Rs 1.30 lakh, the gain before allowable adjustments is Rs 30,000. It is not the entire sale value.

Realised versus unrealised: A rise in the quoted value of an unsold investment is an unrealised gain. The ordinary capital-gains framework generally turns on a transfer, although special statutory situations exist.

Different income: A dividend is a distribution by a company to its shareholders. It is conceptually different from a gain obtained by selling a share.

Holding period: Classification depends on the asset and how long it was held. For ordinary listed equity shares, holding for more than twelve months generally makes the asset long-term; twelve months or less is short-term.

Asset specificity: These periods must not be applied indiscriminately to property, unlisted shares, specified debt funds or other instruments, which may have different provisions.

Policy reason: Holding-period distinctions can influence whether investors retain assets or sell them. Tax design must balance such incentives against simplicity and avoidance risks.

Current framework: The Income-tax Act, 2025 applies to tax years beginning on or after 1 April 2026. Earlier tax years continue under the saved provisions of the 1961 Act.

Qualifying short-term gains: Section 196 of the 2025 Act specifies a 20% rate for covered equity-related short-term gains, subject to its transaction conditions.

Qualifying long-term gains: Section 198 specifies 12.5% on covered long-term gains exceeding an aggregate Rs 1.25 lakh in the tax year. It contains conditions relating to the asset and Securities Transaction Tax, with specified exceptions.

Scope: These are statutory base rates; applicable surcharge and cess can increase liability. The Rs 1.25 lakh amount concerns eligible gains, not the value of shares sold or a separate allowance for each transaction.

Transaction tax: STT is charged on the value of specified securities transactions under its legal framework.

Gains tax: Capital gains tax concerns computed gains. A transaction can therefore attract STT even when the investor makes a loss.

Policy debate: Having both levies raises questions about the overall burden, ease of collection and treatment of different trading and investment activities. Abolishing or reducing one does not automatically alter the other.

Portfolio participation: Foreign portfolio investors invest in securities such as shares and bonds within the relevant regulatory framework. SEBI regulates their market participation.

FDI distinction: Foreign direct investment concerns a different regulatory category associated with investment in enterprises and a lasting interest. FPI and FDI should not be used interchangeably simply because both bring foreign capital.

Economic role: Portfolio flows can support liquidity and financing conditions, but can also reverse when global yields, perceived risks or investment opportunities change.

Hypothetical investment: An investor converts USD 1,000 at Rs 80 per dollar and purchases shares for Rs 80,000. The shares are later sold for Rs 88,000.

Rupee return: The investment has gained Rs 8,000, or 10%, before taxes and expenses.

Currency effect: If the exchange rate at sale is Rs 90 per dollar, Rs 88,000 converts into about USD 977.78. The investor has a dollar loss of about 2.22%, despite the rupee gain.

Interpretation: The example isolates exchange-rate effects. It ignores dividends, hedging, fees and taxes, and is an illustration rather than a forecast.

Measurement issue: The proposal concerns the currency basis used to measure the investment gain. Depending on its eventual design, it could recognise the investor's foreign-currency return instead of looking only at the rupee difference.

Separate concepts: Measuring a gain in dollars does not necessarily mean paying Indian tax in dollars. Nor does it mean dollarising India's economy or guaranteeing a foreign investor against every currency loss.

Symmetry: Rupee depreciation reduces an unhedged investor's dollar return, while appreciation can increase it. A coherent design must address both directions, exchange-rate dates, losses and the interaction with hedging.

Conditional provision: Section 72(6) of the 2025 Act provides a foreign-currency computation method for certain non-resident transfers of shares or debentures of Indian companies.

Important limits: That provision excludes equity shares referred to in section 198. Section 210(5), governing specified funds and Foreign Institutional Investors, separately disapplies section 72(6) for the securities gains covered there.

Implication: Existing conditional provisions do not establish a general dollar-computation entitlement for all FPIs. Any proposed expansion must be read against the precise applicable special rules.

After-tax return: A lower tax on a given taxable gain increases the amount an investor retains, other things equal.

Investment incentives: Supporters expect improved attractiveness of domestic markets, reduced incentives to postpone sales and stronger investor confidence.

Limits: Earnings, valuations, global interest rates, governance, currency expectations and policy certainty also affect investment. A tax cut cannot guarantee higher stock prices or sustained foreign inflows.

Fiscal cost: A lower rate can reduce revenue on a given base. Greater transactions or investment might partly offset that loss, but the extent is an empirical question.

Policy perspective: A Financial Express editorial favours examining overlapping levies, revenue needs and tax certainty before making concessions to lift markets. This is an editorial argument, not a government decision.

Distribution: Financial assets are unevenly held. Broad concessions may disproportionately benefit large asset owners, requiring comparison with expenditure needs and treatment of other income.

Resident–non-resident treatment: Currency-adjusted relief may address a real economic difference, but unequal treatment of similar investments needs a clear rationale and safeguards.

Administration: Rules must handle multiple purchase lots, different funding currencies, losses, treaty interaction and avoidance. Frequent revisions can undermine certainty even when each change offers relief.

Different measures: GDP measures value added across the economy over a period. A stock index tracks the prices of a selected group of listed companies.

Forward-looking prices: Share valuations incorporate expectations of future profits, discount rates and risk. Strong current GDP growth may already be reflected in prices or may benefit sectors poorly represented in the index.

Comparability: Price-index returns differ from total returns that include dividends. Domestic-currency and dollar returns, start dates and sector weights must also be aligned before comparing markets.

Primary market: New securities issues can raise resources for the issuer.

Secondary market: Trading existing securities usually transfers ownership between investors rather than directly providing fresh funds to a company.

Indirect channel: Better liquidity and valuation can improve future fundraising conditions. The policy test should therefore include productive financing and stable participation, alongside turnover and short-term market sentiment.