Foreign Fund Sell-Off to Boost Government’s Capital Gains Tax Collection

Surge in FPI Selling May Lead to Higher Revenue for the Government

The ongoing sell-off by Foreign Portfolio Investors (FPIs) in Indian equities could provide a significant boost to the government’s capital gains tax (CGT) revenue, as several funds book substantial profits on their holdings before exiting the market.

Industry estimates suggest that the Centre could collect over $1 billion (approximately ₹8,714 crore) in capital gains tax for the financial year 2024-25 (assessment year 2025-26). This projection is based on the recent spike in foreign institutional investor (FII) outflows, which has historically correlated with increased CGT collections.

FPI Selling and Capital Gains Tax Collection: A Strong Correlation

FPI Sell-Off Trends in FY25

According to National Securities Depository Limited (NSDL) data, FPIs have net sold shares worth ₹1.23 lakh crore in the ongoing fiscal year. The trend has been even more pronounced in the past two quarters:

• October 1, 2024 – Present: FPIs sold shares worth ₹2.24 lakh crore.
• Q1 FY25: Net FPI outflows stood at ₹7,694 crore.
• Q2 FY25: FPIs were net buyers, purchasing stocks worth ₹97,935 crore.

This large-scale profit booking by foreign funds is expected to result in higher CGT collections for the government.

Historical Trends Support the Pattern

An analysis of past FPI sell-offs and CGT collection data indicates a direct relationship:

• FY22:

  • FPIs sold shares worth ₹1.4 lakh crore.
  • Long-Term Capital Gains (LTCG) tax collection surged by 123% to ₹86,076 crore.
  • Benchmark Sensex gained 16% during the year.

• FY23:

  • FPIs offloaded ₹37,632 crore worth of shares.
  • LTCG tax collection increased 15% to ₹98,681 crore.
  • The Sensex saw a 2.9% decline that year.

These trends suggest that whenever FPIs sell in large volumes, capital gains tax revenues increase significantly.

Higher Tax Rates Amplify Government Revenues

Tax experts highlight that recent changes in CGT rates are expected to further boost collections.

• As of July 23, 2024, the government raised capital gains tax rates:
  • LTCG tax increased from 10% to 12.5%.
  • Short-Term Capital Gains (STCG) tax rose from 15% to 20%.

This means that all profits realized from equity sales are now subject to higher tax rates, directly benefiting the government’s tax revenue.

“The government’s decision to hike LTCG and STCG tax rates ensures that the current FPI sell-off will translate into significantly higher tax collection,” said Suresh Swamy, Partner at Price Waterhouse & Co LLP.

Are Surging Capital Gains Tax Collections Sustainable?

Despite the short-term revenue gains, some experts warn that capital gains tax collections from FPI sell-offs are unpredictable and cannot be relied upon as a stable revenue source.

“Sudden surges in capital gains tax due to steep selling in the market—often triggered by panic or speculative exits—are temporary and volatile,” said Ritika Nayyar, Partner at Singhania & Co.

Market fluctuations, global economic conditions, and investor sentiment play a significant role in influencing capital gains tax revenue, making it an unreliable long-term revenue stream for the government.

Securities Transaction Tax (STT) Collection Also Expected to Rise

In addition to CGT, the Securities Transaction Tax (STT) collection is also expected to rise significantly due to increased trading activity.

• The government estimates STT revenue for FY26 at ₹78,000 crore, a 40% increase from the ₹55,000 crore target for FY25.
• In FY20, STT collections were just ₹12,374 crore, indicating a sharp rise in trading tax revenue over the years.

“A sharp increase in market turnover due to FPI sell-offs means higher STT collections, benefiting government revenues,” said a tax consultant tracking market trends.

Higher Trading Volumes Indicate Increased STT Revenue

According to SEBI data, market turnover has risen sharply in FY25:

• NSE’s average daily turnover:
  • 42% increase to ₹1.16 lakh crore (compared to ₹81,721 crore in the previous year).
• BSE’s average daily turnover:
  • 24% rise to ₹8,226 crore (from ₹6,622 crore in FY24).
• Total equity trades in FY25 (until January 31) are already 17% higher than the full-year total for FY24.

“The rich valuations of Indian stocks have led to larger transaction sizes, automatically increasing STT outflows,” explained a market analyst.

Market Sell-Off Driven by High Valuations and Global Factors

The current FPI sell-off began after Indian markets hit all-time highs in mid-September. Key reasons include:

• Overvaluation concerns leading to profit-booking.
• Rising US interest rates, reducing the relative attractiveness of Indian equities.
• Global economic uncertainty prompting investors to rebalance portfolios.

“The Indian equity market has been one of the best-performing markets globally. However, many FPIs who entered years ago are now cashing out, realizing significant capital gains,” said SR Patnaik, Head of Taxation at Cyril Amarchand Mangaldas.

A Windfall for Government Revenues but a Temporary Boost

While the current wave of FPI selling is expected to generate a windfall for the government in capital gains and STT collections, experts caution that this trend is unlikely to be a sustainable revenue stream.

Going forward, the government will need to balance its taxation policies to ensure India remains an attractive investment destination while still maximizing tax revenues from market activity.

As the budget for FY26 approaches, policymakers will likely face critical decisions on whether to adjust capital gains tax structures or introduce new incentives to retain long-term foreign investors.