OPINION | India’s economic future hinges on interest income tax reform

Reforming the punitive tax regime on interest income for individual investors is not merely a fiscal consideration; it is a strategic imperative

India’s economic ambitions hinge critically on the development of world-class infrastructure and domestic manufacturing. Yet, a formidable obstacle remains: mobilising sufficient, affordable debt capital. Greenfield infrastructure development and manufacturing often carry inherent risks and modest credit ratings, making financing expensive and challenging. At the core of this challenge lies an often overlooked issue — the country’s punitive taxation of interest income for individual investors.

The Punitive Interest Income Tax Burden

Indian individuals currently pay income tax on interest earnings at slab rates that can soar up to 30%, accompanied by surcharges and cess. This applies uniformly across interest sources — from bank deposits to bonds, mutual funds, REITs, and InvITs. By contrast, corporate entities and foreign investors have access to sophisticated tax planning, deductions, and international treaty benefits that significantly reduce their effective tax rates, often to the range of 10–15%.

Consequences: Capital Flight and Misdirected Investments

This steep tax burden discourages individuals, particularly high-net-worth investors, from channelling funds into stable, regulated fixed-income instruments that are critical for infrastructure financing. Instead, capital often migrates offshore in search of more favourable tax regimes or pivots towards equities and derivatives, where tax incentives offer more palatable after-tax returns.

The fallout is twofold:

1. Domestic capital formation is adversely impacted. This is particularly acute in lower-rated, higher-risk debt capital markets.

2. Institutional investors and mutual funds have, by design and default, concentrated on providing debt to higher-rated borrowers. This is reflected in our underdeveloped bond markets, which are dominated by high-rated issuers.

As a result, lower-rated debt capital for infrastructure development, SMEs, and greenfield manufacturing by newer entrepreneurs faces a scarcity of patient, risk-tolerant capital.

AIFs: Bridging the Financing Gap — But Hampered by Tax Policy

This financing gap is increasingly being addressed by private credit through Alternative Investment Funds (AIFs). Many of these AIFs invest in high-risk, lower-rated borrowers, including SMEs. The majority of capital for such AIFs is raised from high-net-worth individuals (HNIs) and family offices — the very segment seeking better tax jurisdictions to migrate their capital.

AIFs have the potential to mobilise debt capital at scale from both domestic and global investors. However, the punitive individual tax regime hampers greater participation and limits the democratisation of debt financing.

A Pragmatic Policy Path Forward

CBDT data for AY 2023–24 reveals that individual taxpayers collectively earned over ₹41 lakh crore in interest income — a significant portion of which is subjected to the highest tax slabs. A targeted tax reform — taxing interest income earned by individuals from regulated investment vehicles such as AIFs at a concessional rate of around 15% — offers a compelling solution.

Such a measure would:

* Institutionalise and organise capital with higher risk appetite.

* Address the gap in risk-tolerant debt financing.

* Align individual tax treatment more closely with international norms and treaty benefits enjoyed by foreign investors.

India’s roadmap to economic development demands unprecedented infrastructure investments — stretching into multiple lakh crores annually. Without a steady flow of affordable debt financing, construction delays and inflated costs will undermine these critical national goals.

Benefits of Reform

- Stimulate Domestic Investment: Reduced tax burden curtails capital flight and broadens the tax base.

- Unlock Domestic Capital: Improved after-tax returns encourage capital flow into infrastructure, SMEs, and greenfield manufacturing.

- Lower Financing Costs: Broader investor participation drives down capital costs for developers.

- Support National Development Goals: Steady infrastructure financing fuels economic growth, employment, and improved quality of life.

India’s economic future — its roads, power grids, transport hubs — depends on our collective ability to harness capital efficiently and affordably. Reforming the punitive tax regime on interest income for individual investors is not merely a fiscal consideration; it is a strategic imperative for building the infrastructure that will sustain India’s long-term growth and prosperity.

This reform is a simple yet powerful lever to accelerate India’s infrastructure revolution and realise the vision of a Viksit Bharat.

(Srini Sriniwasan is the Managing Director, Kotak Alternate Assets Managers Limited.)

The views and opinion expressed in the column are personal and do not necessarily reflect the opinion of the organisation or the Kotak Group.

Views are personal and do not represent the stand of this publication.