FPI sell-off may give a boost to government's capital gains tax collection

FPIs have been on a selling streak since October.

The ongoing sell-off by foreign funds in Indian equities may provide a booster shot to the Centre's tax collection, as several of these funds have made tidy profits on their shares before selling.

Capital gains tax has already become a key source of revenue for the government and industry estimates suggest the government may collect anywhere over a billion dollars (Rs 8,714 crore) in capital gains tax for financial year 2024-25 (assessment year 2025-2026).

In the current fiscal, foreign funds have, so far, net sold shares worth Rs 1.23 lakh crore, NSDL data shows. In the past two quarters, starting October 1, 2024, foreign funds have sold shares worth Rs 2.24 lakh crore.

In first quarter, FPIs sold shares worth Rs 7,694 crore, while in the second quarter, they bought shares worth Rs 97,935 crore, data showed.

Data analysed by Moneycontrol shows a correlation between FPI selling and collection of capital gains tax. For instance, a Rajya Sabha reply from the Finance Ministry in 2024 pointed out that in FY22 long-term capital gains (LTCG) tax collection surged 123 percent to Rs 86,076 crore, as FPIs sold shares worth Rs 1.4 lakh crore. The benchmark Sensex had gained 16 percent during the year.

Similarly, in FY23 LTCG tax collection rose 15 percent to Rs 98,681 crore, as FPIs offloaded shares worth Rs 37,632 crore. The Sensex fell 2.9% during the year.

“The current profit booking by FPIs is surely expected to lead to higher capital gains tax collection for the government,” said Suresh Swamy, partner, Price Waterhouse & Co LLP.

“It should be noted that the government had increased the tax rates on equity shares from 10 percent to 12.5 percent (on long term) and from 15 percent to 20 percent (on short term) w.e.f. 23 July 2024. These changes mean that any profits realised from the sale of equity shares will now be subject to higher tax rates, thereby increasing the overall tax collection from such transactions.” Swamy added.

Experts, however, caution that such surges in capital gains tax are not sustainable. “Sudden surges in capital gains collections due to steep selling in the market, often triggered by panic selling or speculative activity, are transient and unpredictable. These windfall gains, driven by various external economic and political factors, should not be mistaken for a consistent revenue stream,” said Ritika Nayyar, partner, Singhania & Co.

An email sent to the finance ministry remained unanswered.

STT collection seen rising

Tax experts say the FPI sell-off is also expected to provide buoyancy to Securities Transaction Tax (STT) collection.

For FY26, the government is expecting STT collections to rise 40 percent to Rs 78,000 crore from Rs 55,000 crore estimated for FY25. Five years ago, the government earned just Rs 12,374 crore from STT.

The sell-off started after the market hit its lifetime highs in mid-September. Due to the rich valuations, the transaction sizes are higher implying higher STT outgo.

According to the data published by market regulator the Securities and Exchange Board of India (Sebi), the average daily turnover in the cash market at NSE rose 42 percent in FY25 to Rs 1.16 lakh from Rs 81,721 crore in the previous year .

Similarly, the average daily turnover of BSE went up 24 percent in FY25 to Rs 8,226 crore from Rs 6,622 crore in FY24, data showed. The total number of equity trades in the FY25, until January 31, was 17 percent higher than those for full FY24.  These metrics indicate higher level of transactions in the markets implying higher STT.

"Indian equity market has been one of the outperformers in the last couple of years.A lot of money that was invested a few years back, has resulted in significant amount of capital gains for the investors, including FPIs, who have also contributed to the steep outflows. The fact that these funds are taking back a huge amount of capital gains, also cannot be ignored.” said SR Patnaik, head of taxation, Cyril Amarchand Mangaldas.