As India prepares for the Union Budget 2027–28, SEBI has reportedly placed some significant tax reform proposals before the Finance Ministry. From removing long-term capital gains tax for foreign investors to making mutual fund switches tax-neutral, these recommendations could reshape India's investment landscape. But how much of this is likely to become reality?

There is an interesting conversation taking place in India's financial markets ahead of the Union Budget 2027–28.

The Securities and Exchange Board of India (SEBI) has reportedly submitted a series of pre-Budget recommendations to the Finance Ministry, seeking a rethink of certain aspects of India's capital gains taxation framework.

At first glance, these may appear to be a few isolated tax proposals. But look a little deeper and they point towards a larger question: Is India's existing tax structure becoming a constraint on the competitiveness of its capital markets?

The proposals come at a time when Indian equities have been under pressure, foreign portfolio investors have been withdrawing significant capital, and domestic investors have increasingly become the backbone of the market.

Two recommendations stand out.

1. Removing the 12.5% LTCG tax for foreign portfolio investors

SEBI has reportedly recommended removing the 12.5% long-term capital gains (LTCG) tax applicable to foreign portfolio investors (FPIs) investing in Indian equities.

To understand the significance, consider the current taxation framework.

Under the existing rules, eligible listed equity investments and equity-oriented mutual funds held for more than 12 months attract LTCG tax at 12.5% on aggregate gains exceeding ₹1.25 lakh in a financial year. Short-term capital gains on eligible transactions are taxed at 20%, subject to applicable conditions.

Foreign investors also have to factor in Securities Transaction Tax (STT), withholding taxes on dividends and other transaction-related costs.

SEBI's argument, as reported, is that the cumulative cost of investing in Indian equities is relatively high compared with competing markets.

The timing is important.

According to Reuters, foreign investors have sold approximately $31 billion worth of Indian equities in 2026. India's benchmark Nifty 50 has also underperformed several emerging market peers over the last two years.

The underlying concern is straightforward: global capital is mobile. Investors compare markets not just on growth prospects and valuations, but also on the returns they can retain after taxes and transaction costs.

If Singapore, Hong Kong or other competing financial centres offer more favourable capital gains treatment, India needs to consider whether its tax framework is competitive enough to attract and retain international capital.

Removing LTCG tax for FPIs could improve India's relative attractiveness.

However, it is important to remember that taxation is only one component of foreign investment decisions. Currency depreciation, corporate earnings, valuations, global interest rates, geopolitical developments and relative growth opportunities are equally important.

A tax concession may improve the economics of investing in India, but it cannot independently guarantee foreign capital inflows.

2. Tax-neutral switching between mutual fund schemes

Arguably, the more interesting proposal for domestic retail investors is SEBI's recommendation to allow tax-neutral switching between mutual fund schemes, provided the existing investments have been held for more than one year.

Currently, switching from one mutual fund scheme to another is generally treated as a redemption from the original scheme and a fresh investment into the new scheme.

This means that even when an investor is not withdrawing money from the market, a switch can trigger a capital gains tax liability.

Consider a simple example.

An investor puts ₹10 lakh into an equity mutual fund. Over time, the investment grows to ₹15 lakh.

The investor now believes the portfolio needs to be rebalanced, perhaps moving from a small-cap fund to a flexi-cap fund or shifting exposure between different investment strategies.

Under the current framework, redeeming the original investment can trigger capital gains tax on the ₹5 lakh appreciation, subject to applicable exemptions and conditions.

This creates a frictional cost.

The investor may have a perfectly valid portfolio-management reason to change funds, but taxation becomes a consideration in deciding whether to make that change.

SEBI's reported recommendation seeks to address this issue.

If implemented appropriately, investors could potentially switch between eligible mutual fund schemes without triggering an immediate capital gains tax liability, provided the holding-period requirement is satisfied.

This could have several implications:

• Investors could rebalance portfolios more efficiently.

• Financial advisors could recommend changes based on asset allocation and investment objectives rather than tax considerations alone.

• Investors could move away from underperforming or unsuitable schemes without necessarily facing an immediate tax outgo.

• The mutual fund industry could benefit from greater flexibility in managing long-term investor portfolios.

There is, however, an important distinction to be made. The final rules would need to clarify whether the relief represents tax exemption or tax deferral, how the original cost of acquisition and holding period would carry forward, and which types of switches would qualify.

These details will determine the actual benefit.

3. Why are these proposals coming now?

To understand the timing, we need to look at the broader Indian capital market environment.

India has spent the last decade building a significantly deeper equity market.

Mutual fund participation has expanded, SIP investments have become a mainstream savings vehicle, demat accounts have grown substantially, and retail participation in equities has increased.

Domestic institutional investors, particularly mutual funds, have emerged as an important counterweight to foreign investor selling.

However, there is another side to this story.

Foreign capital remains important for market liquidity, price discovery, institutional participation and the overall depth of the Indian equity market.

When foreign investors consistently sell, domestic institutions can absorb some of the supply, but this does not mean foreign capital has become irrelevant.

The reported proposals suggest that SEBI is attempting to address some of the structural friction points in India's investment ecosystem.

There is also a competitive dimension.

Countries compete for global capital. Taxation, transaction costs, regulatory predictability and ease of doing business all influence where international investors allocate money.

India wants to become a larger destination for global capital. Its tax policies need to be evaluated in that context.

4. Will the government actually implement these proposals?

This is perhaps the most important question.

There is a difference between a regulator submitting a recommendation and the Finance Ministry accepting it as government policy.

SEBI can identify structural problems, represent industry concerns and recommend changes. However, taxation is ultimately a matter for the Central Government and Parliament.

There are reasons to believe these proposals will receive serious consideration.

First, the Finance Minister, Nirmala Sitharaman, has publicly acknowledged the concerns of foreign investors around India's capital gains tax structure.

On November 2, 2026, she indicated that the government would first listen to the concerns of FPIs before considering possible changes. She also acknowledged that the circumstances surrounding foreign investment had changed since 2023.

Second, the government has already acknowledged that proposals to review equity LTCG taxation are under examination.

Third, attracting long-term investment capital is important for India's economic ambitions. A growing economy requires capital to finance businesses, infrastructure, innovation and expansion.

However, there are equally important reasons why the proposals may not be accepted in their entirety.

The revenue question: Capital gains taxation contributes to government revenues. Removing or reducing it would have fiscal implications, and the government would need to assess whether the potential benefits from higher investment flows justify the revenue sacrifice.

The equity question: Domestic retail investors currently pay capital gains tax on eligible equity investments. A complete exemption for foreign investors could create questions around tax parity between domestic and foreign participants.

The market impact question: Tax incentives do not automatically translate into sustainable investment inflows. Foreign investors may continue to prefer other markets if valuations, earnings prospects or currency conditions are more attractive elsewhere.

The policy-design question: Tax-neutral mutual fund switching would require careful drafting to prevent misuse, artificial tax avoidance and frequent switching purely for tax arbitrage.

Our assessment is that the government has a stronger case for examining targeted reforms than for assuming that every recommendation will be accepted in its original form.

The mutual fund switching proposal is a particularly interesting candidate for a carefully designed reform because it addresses an existing friction in long-term portfolio management.

The FPI capital gains proposal is a bigger fiscal and policy decision, and the government may consider a calibrated alternative rather than complete abolition.

These are assessments, not confirmed government decisions.

5. What could investors gain if these proposals are implemented?

The implications extend beyond simply saving tax.

For domestic mutual fund investors, tax-neutral switching could make portfolio management more efficient.

Imagine an investor who has accumulated a substantial mutual fund portfolio over 10–15 years. As financial goals change, the investor may need to move from aggressive equity funds towards more diversified strategies or gradually reduce equity exposure.

Under the current framework, every switch can potentially create a taxable event.

Removing this friction could make long-term portfolio rebalancing easier.

It could also encourage investors to think about their portfolios as a consolidated financial plan rather than a collection of individual mutual fund schemes.

For foreign investors, removing LTCG taxation could improve post-tax returns and potentially make Indian equities more competitive against other emerging markets.

But we should not confuse improved market attractiveness with an immediate market rally.

Market prices are ultimately driven by earnings, valuations, liquidity, interest rates and expectations. Taxation is one variable in that equation.

6. What should investors do in the meantime?

At ARKa Invest, we believe investors should distinguish between policy expectations and actual investment decisions.

There is always a tendency for markets and investors to start pricing in potential policy changes well before they are formally announced.

However, building an investment strategy around an unapproved tax proposal is rarely a sound approach.

Our approach would be to:

1. Avoid premature portfolio switches: Do not delay or accelerate a necessary portfolio decision solely because of a possible tax exemption.

2. Focus on asset allocation: The quality of your asset allocation, diversification and investment horizon will have a far greater bearing on long-term wealth creation than a potential change in one tax provision.

3. Evaluate funds on merit: Investors should not remain invested in an unsuitable or consistently underperforming fund simply to avoid capital gains tax.

4. Understand the final legislation: Even if the government accepts the recommendations, the eligibility conditions, holding periods, grandfathering provisions and tax treatment will matter.

5. Think long term: Tax efficiency is important, but it should support a sound investment strategy rather than dictate one.

The bigger picture: India needs capital, but capital needs confidence

The larger takeaway from SEBI's recommendations is that India may be entering an important phase of reassessing its capital market taxation framework.

The country has successfully encouraged millions of households to participate in financial markets. The next challenge is to make these markets more efficient, globally competitive and supportive of long-term capital formation.

The government's challenge will be to balance three objectives: protecting tax revenues, maintaining fairness between investor categories, and attracting the capital required to finance India's economic growth.

Whether these proposals are accepted in full, modified or deferred will become clearer as the Budget process progresses.

For now, investors should treat them as important policy signals rather than assured tax benefits.

At ARKa Invest, our view is simple: good tax policy should encourage investment, not distort investment decisions. The objective should be to create an ecosystem where capital can move efficiently, investors can make rational portfolio decisions, and long-term wealth creation is rewarded.

After all, the real purpose of investing is not to save tax on a transaction. It is to build wealth over time.