Foreign portfolio investors (FPIs), including pension funds, university endowments, and some sovereign funds, are facing a new dilemma: how to utilize the India tax credits they will receive for the current financial year. Tax experts suggest these tax credits could become a “sunk cost” for many of these foreign investors, adding to the complexities they are already dealing with amid ongoing market volatility.
Tax Credits from Capital Gains Payments
Recently, FPIs have been trimming their exposure to Indian stocks, resulting in significant capital gains tax liabilities under India’s Double Tax Avoidance Agreements (DTAAs). When foreign funds sell Indian equities, they are required to pay capital gains tax in India, but they also receive tax credits for these payments. These credits can usually be used to offset their tax liabilities in their home countries. However, most of these funds, such as pension funds and sovereign wealth funds, are exempt from taxes in their home jurisdictions, making the Indian tax credits largely unusable.
This issue arises at a time when foreign funds have been on a selling spree, with data from the National Securities Depository Limited (NSDL) showing that FPIs have net sold equities worth a staggering Rs 2.24 lakh crore since October.
The ‘Sunk Cost’ Dilemma
According to Suresh Swamy, Partner at Price Waterhouse & Co LLP, the tax credits for capital gains tax paid in India may end up as a sunk cost for many FPIs. “FPIs that are tax-exempt in their home countries may not be able to utilize the tax credits received in India for capital gains tax payments, as they do not have corresponding tax liabilities in their domestic jurisdictions. As a result, the tax paid in India would effectively be a sunk cost for such investors, forming part of the overall cost of doing business in the Indian market,” he explains.
Challenges in Offsetting Capital Gains Taxes
Indian tax laws allow for capital gains tax to be offset against capital losses over an eight-year period. However, given the size of the capital gains involved, tax experts argue that it is unlikely that FPIs will be able to fully adjust their capital gains tax payments against losses. This presents a significant challenge for tax-exempt investors like pension funds and university endowments, who face an additional tax burden due to their inability to utilize these tax credits.
Ritika Nayyar, Partner at Singhania & Co., highlights the issue, stating, “The current tax framework presents a challenge for certain FPIs, such as pension funds and university endowments, due to their inability to utilize Indian tax credits in their home country because of their tax-exempt status there. This disparity can impact their strategies regarding India as an investment jurisdiction, especially for long-term, stable capital.”
Additional Tax Considerations for FPIs
Apart from capital gains tax, FPIs also pay Securities Transaction Tax (STT) and stamp duty on the sale or purchase of shares. Unlike capital gains tax, STT and stamp duty do not come with any associated tax credits, adding to the overall cost for foreign investors.
Debate Over Long-Term Capital Gains Tax
This situation comes amid ongoing debates within Indian markets about whether the government should scrap the long-term capital gains (LTCG) tax on equities. The government streamlined the tax rates last year by introducing a single rate of 12.5% across all asset classes for long-term capital gains, while the short-term capital gains tax remains 20% for all asset classes.
As of January 31, 2025, sovereign wealth funds held equity assets worth Rs 4.87 lakh crore, while pension funds held Rs 5.86 lakh crore. The total shareholding by FPIs was valued at Rs 67.7 lakh crore, highlighting their significant presence in the Indian equity market.
