Market veteran Deepak Shenoy has backed reports that India may consider removing taxes on foreign institutional investors (FIIs) investing in Indian bonds, calling the move an important step toward making Indian debt markets more globally competitive and attracting long-term foreign capital.
In a detailed post on social media platform X, the Founder and CEO of Capitalmind argued that India’s current tax treatment for foreign portfolio investors (FPIs) is significantly different from most major economies and creates friction for overseas investors allocating money to Indian debt markets.
“Foreign investors pay tax on all capital gains made in India. India is different from all major economies who follow residence based taxation meaning capital gains are taxed in the country of your residence not the country in which you invest,” said Deepak Shenoy, Founder and CEO, Capitalmind.
Shenoy explained that in many developed markets, investors are taxed in their country of residence rather than where they invest. For instance, Indian investors earning capital gains on US-listed stocks are taxed in India, while the United States generally does not tax those gains directly.
According to Shenoy, India’s taxation framework becomes particularly problematic in the bond market because foreign investors are taxed on capital gains arising from bond price movements. Bond prices typically rise when interest rates fall, meaning FPIs may incur taxable gains even when they are merely tracking benchmark bond indices.
Why foreign investors face difficulties in Indian bonds
Shenoy highlighted that global index funds investing in Indian bonds may struggle to match benchmark returns because taxes deducted in India reduce actual realised gains.
“For bonds it is a pain because you get taxed for a capital gain at 20% in India. The FPI may be an index fund buying a bond index in which Indian securities are, and they will underperform that index because the tax is deducted in India at source,” said Deepak Shenoy, Founder and CEO, Capitalmind.
He also pointed out that Indian domestic institutions such as mutual funds, insurance companies and pension funds do not face similar tax burdens on bond investments, creating an uneven playing field between local and foreign investors.
Apart from capital gains taxation, Shenoy said the treatment of accrued interest in secondary bond transactions creates additional complications for foreign investors.
When bonds are bought in the secondary market, buyers typically pay accrued interest to sellers for the period since the last coupon payment. According to Shenoy, FPIs often face taxation even on this accrued interest component, while some foreign jurisdictions may not provide tax credits for taxes already deducted in India.
“Apparently FPIs get hit because even getting paid that accrued interest when they sell a bond has that tax, and if their jurisdictions don’t tax mutual funds or pension funds there is no corresponding tax in their home countries to offset what’s paid in India,” said Deepak Shenoy, Founder and CEO, Capitalmind.
Shenoy further criticised the tax deduction at source (TDS) structure on interest income. According to him, even though the effective tax rate on interest may be lower, FPIs often face a much higher TDS deduction initially and then have to wait months for refunds.
Could tax reforms help India attract more foreign capital?
Shenoy argued that India should move towards making capital gains on listed bonds completely tax-free for foreign investors and reduce interest-related TDS burdens substantially.
“India should get moving with this and make capital gains and interest on listed bonds paid to FPIs totally tax free on cap gains and only 5% TDS on interest or none at all. It won’t reverse FPI flows really but in the long term it will attract foreign capital,” said Deepak Shenoy, Founder and CEO, Capitalmind.
He also suggested that India should eventually consider removing capital gains taxes on stock investments for foreign investors as well, similar to the treatment available to many domestic institutional investors.
According to Shenoy, aligning India’s taxation framework more closely with international standards could improve the attractiveness of Indian financial markets, deepen bond market participation and support the long-term internationalisation of the rupee.
The debate around taxation of foreign investors has gained importance as India increasingly seeks inclusion in global bond indices and aims to attract stable overseas capital flows into domestic debt markets. Market participants believe easing tax-related complexities could help improve liquidity, broaden investor participation and strengthen India’s position in global fixed-income markets over time.
Disclaimer: The views and recommendations made above are those of individual analysts or broking companies, and not of Mint. We advise investors to check with certified experts before making any investment decisions.
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