Union Cabinet's Tax Policy Changes and Implications for Investment

The Union Cabinet's decision to abolish capital gains tax on Foreign Portfolio Investment (FPI) holdings in government securities aims to enhance overseas investments in India. Notably, India's net Foreign Direct Investment (FDI) has significantly declined from $45 billion in FY21 to merely $0.35 billion in FY25, primarily due to increased profit repatriation and insufficient inflows.

Key Factors Affecting FDI

• Global dynamics such as China Plus One near-shoring strategies.
• Geopolitical tensions from the US-Iran conflict.
• Opportunities in the US and East Asia.
• Adverse effects of AI on Indian IT services.

Challenges Within India's Tax System

Despite progress in simplifying the tax code and eliminating the angel tax, issues remain within India's taxation system, which is crucial for long-term capital investment.

Taxation at Entry

• India levies a stamp duty of 0.005% on share issuance and 0.015% on transfers, comparable to China, but lower than Britain.

Taxation During Holding Period

• Dividends: A 20% withholding tax on non-residents, potentially reducible to 5-15% under treaties. China and Vietnam apply 10% and 0% respectively.
• Royalties & Technical Service Fees: Withholding rate doubled from 10% to 20%, pushing companies to pursue treaty claims for reductions.
• Debt: The lapse of concessional 5% withholding rate on foreign currency borrowings, previously under Sections 194LC and 194LD.

Taxation at Exit

• Long-term capital gains (LTCG) on listed equity is 12.5%, higher than many developed markets which exempt non-residents.
• Frequent changes in equity exit frameworks, contrasting stable regimes in the US and China.

Recommendations for Tax Reforms

• Restoring LTCG on listed equity to 10% for stability and competitiveness.
• Abolishing distortionary Securities Transaction Tax (STT) on cash equity.
• Extending pass-through taxation to Category III Alternative Investment Funds (AIFs).
• Adopting mandatory binding international tax arbitration and a single-window filing architecture for non-resident compliance.

India's tax system needs alignment with global standards, ensuring consistency, predictability, and reduced operational friction to attract foreign investments effectively.