India needs a tiered capital gains tax to retain patient capital

The debate has acquired urgency. FPIs have withdrawn approximately Rs 3.07 lakh crore from Indian equities in 2026 until mid-October. The finance minister has also expressed a willingness to hear views on LTCG and securities transaction tax (STT). The issue deserves serious consideration, not merely as a tax question but as part of a broader discussion on how India attracts and retains capital. At the same time, we must recognise the government’s perspective.

Equity LTCG tax collections increased from Rs 29,220 crore in FY19 to Rs 1.29 lakh crore in FY25. This is a substantial source of revenue. Abolishing the tax would mean potentially giving up a significant sum. Any proposal to reduce this revenue must also explain how the gap can be bridged. The solution, in my view, lies in changing the structure of the tax rather than abolishing it outright. We should move away from a flat rate that treats all long-term investors alike.

Instead, patience should be rewarded—the longer an investor stays invested, the lower the tax rate should be. My proposal is straightforward. Leave STT unchanged, as well as the 20% tax on short-term capital gains. Replace the current 12.5% LTCG tax on listed equities, applicable after a holding period of one year, with a graduated structure: 10% on gains from investments held for more than one year, 5% on gains from investments held for more than two years, and zero tax on gains from investments held for more than three years.

The principle is simple: pay less for patience. This would create a clear incentive to invest with a longer horizon rather than make decisions driven by short-term market movements. Such a structure would also send an important signal to global investors. India wants capital that participates in its long-term growth, not merely capital that enters and exits at the first sign of volatility. Tax policy alone cannot determine foreign investment flows, but it can contribute to making India a more attractive and predictable investment destination.

The obvious question is what happens to government revenue. The answer lies in looking at the capital market ecosystem rather than LTCG collections in isolation. First, there is STT. Unlike LTCG tax, which is payable on realised gains, STT is linked to transactions. Higher trading activity can generate additional revenue even when a transaction does not result in a taxable long-term gain. STT collections rose from Rs 11,528 crore in FY19 to Rs 57,522 crore in FY26, while the Budget estimate for FY27 is Rs 73,700 crore.

This demonstrates the growing importance of transaction-related revenue alongside the expansion of India’s capital markets. Second, LTCG collections depend on market performance, investor participation, and the gains investors eventually realise. The increase from Rs 29,220 crore in FY19 to Rs 1.29 lakh crore in FY25 reflects substantial market expansion and rising participation. A lower tax rate could encourage longer holding periods and potentially greater investment activity.

Higher turnover does not automatically translate into higher taxable gains. The objective must be to create the conditions in which a larger, more durable capital market can support government revenues over time. Third, patient capital has benefits beyond tax collections. More stable foreign investment can deepen our equity markets, support capital formation, and reduce vulnerability to abrupt changes in investor sentiment.

It may also help moderate pressure on the rupee during periods of heavy portfolio outflows. LTCG taxation is not the sole determinant of foreign investment decisions; global interest rates, valuations, currency expectations, and India’s growth prospects all matter. Nevertheless, taxation is one policy lever worth examining. We don’t have LTCG collections by the holding period of the underlying investments, making a precise estimate of the cost of a tiered structure difficult.

However, since the proposed rates are roughly half the current rate on average, we can use a simplified illustration. Applying an average rate of 6.25%, compared with the current 12.5%, to the FY25 collection base of `1.29 lakh crore would imply collections of roughly Rs 64,600 crore, a potential reduction of a similar amount. This is an illustration, not a revenue forecast. The actual impact would depend on the distribution of holding periods, gains realised,and how investors respond to the new structure.

Consider an illustrative scenario in which STT revenue and LTCG collections under the proposed regime increase in proportion to market activity and taxable gains. Using the FY27 STT Budget estimate and the simplified LTCG calculation, a 10% increase would generate around Rs 7,400 crore in additional STT and Rs 6,500 crore in additional LTCG collections. Together, it would recover about 21% of the estimated Rs 64,600 crore difference.

The point is not that additional activity will necessarily bridge the gap, but that the fiscal cost should be assessed against the potential gains from greater participation and a deeper capital market. There are legitimate concerns about fairness and tax neutrality across asset classes. Thus, a tiered tax for long-term equity gains can be justified within the wider tax system. Ultimately, we should aspire to make India a market where investors want to stay invested, not simply one in which they want to invest.

A well-designed tax policy can contribute to that. The principle is worth considering: reward patience and encourage long-term capital formation. The writer is founder & CEO, NovaaOne Capital Pvt Ltd Disclaimer: The views expressed are the author's own and do not reflect the official policy or position of Financial Express.