Centre scraps capital gains, interest tax on FII govt bond investments to pull foreign funds

India’s government announced Friday it will eliminate capital gains and interest taxes on Foreign Institutional Investors (FIIs) investing in government bonds, aiming to pull tens of billions of dollars in foreign funds and ease pressure on the rupee. The move, formalized through an ordinance amending the Income Tax Act, 2025, removes the 12.5% long-term capital gains tax, 30% short-term capital gains tax, and 20% withholding tax on interest income for FIIs and the Bank for International Settlements (BIS). The changes take effect April 1, 2026, and apply to investments under the General Route and Fully Accessible Route (FAR), where FII holdings currently stand at Rs 3.75 lakh crore (3.34% of available bonds). Economists at Axis Bank estimate the tax exemption could bring $45-50 billion in foreign investment over two years, helping mitigate a projected $60 billion balance of payments deficit by 2026-27. The rupee, which has weakened 5% since February 27 and 10.3% over the past year, closed at 95.79 per dollar Thursday before strengthening to 95.45 Friday. Government bond yields also declined following the announcement. Until now, FIIs faced a 12.5% long-term capital gains tax on listed stocks and bonds held over 12 months, a 30% short-term tax, and a 20% withholding tax on interest income—one of the highest rates globally. The Reserve Bank of India (RBI) simultaneously expanded the FAR to include 15-, 30-, and 40-year bonds and removed limits on short-term investments, concentration, and individual securities under the General Route. RBI Governor Sanjay Malhotra stated these measures, combined with the tax benefits, would boost foreign capital for government borrowing. The decision follows months of internal discussions and aligns with earlier reports that the government and RBI were considering tax cuts to attract foreign investment. The BIS, an organization of central banks, remains uninvested in India despite the new exemption. The tax relief applies to both FIIs and the BIS, though losses cannot be offset against past gains for non-resident investors without Indian tax residency.