Amid continuing concerns over the economy and with the aim of attracting foreign investment, the government has taken a major step. The government has decided to abolish capital gains tax on foreign investors investing in Indian government bonds. Sources told *India Today* that the proposal was approved by the Union Cabinet on Wednesday.
The approval is part of broader efforts to boost capital inflows, strengthen the rupee and cushion the economy from the impact of the ongoing conflict with Iran and high crude oil prices. The Cabinet also approved an ordinance to amend the Income Tax Act to implement these changes. This decision will come into effect after getting the assent of the President.
The move comes at a time when India is facing challenges such as record outflows by foreign investors, pressure on the rupee and rising energy costs due to the long-running conflict in the Middle East. According to reports, RBI had recommended the government to reduce the tax burden on foreign bond investments.
**What are the current rules?**
Under current rules, foreign investors have to pay short-term and long-term capital gains tax on their bond investments in India. If the bonds are held for a period of more than 12 months, a long-term capital gains tax of 12.5% applies. Conversely, if the bonds are sold in less than 12 months, the investor has to pay a hefty short-term capital gains tax of 30% to 40% depending on the category.
However, after the issuance of the ordinance, this capital gains tax on government securities will be completely waived (made zero). Earlier, foreign investors also had to pay 20% withholding tax (tax deducted at source) on the interest earned from these investments. The government is now working on a comprehensive package to halve this 20% tax or provide significant relief in this regard. This was the reason why historically many foreign investors stayed away from the Indian bond market.
**Impact on economy and rupee**
Due to the escalating conflict between the US and Iran and the ongoing global uncertainty, Indian markets have seen a total sell-off of ₹2.47 lakh crore so far this year. As a result, the rupee has also fallen to a low of 96.96. With the tax being removed, large global funds – especially sovereign wealth funds and pension funds – can invest $10 billion to $30 billion (₹80,000 crore to ₹2.5 lakh crore) every year in India’s debt market. As foreign investors pour dollars into the market to buy Indian bonds, the inflow of dollars will increase. This is expected to strengthen the rupee.
**Fall in bond yields**
Due to vigorous buying, yields (interest rates) on Indian government bonds are likely to fall. The fall in bond yields directly means that the government will have to pay less interest to raise debt, which will reduce the fiscal deficit.
