India Opens Door Wider to Foreign Capital With New Tax Exemption

The Centre on Friday announced the Income-tax (Amendment) Ordinance, 2026, exempting foreign investors from paying taxes on interest income and capital gains earned from government securities.

Media reports on Thursday had indicated that the Ministry of Finance had moved the proposal before the Cabinet, while additional measures were announced in coordination with the Reserve Bank of India.

The move comes against the backdrop of a depreciating rupee, which has come under pressure from foreign fund outflows.

The tax exemption, along with the financial market measures announced by the RBI's Monetary Policy Committee, is expected to attract foreign capital inflows and help support the domestic currency.

The ordinance, issued on Friday, takes retrospective effect from April 1, 2026. Promulgated by President Droupadi Murmu, it was issued while Parliament is not in session, with the President satisfied that "circumstances exist which render it necessary ... to take immediate action."

"It is a significant step towards strengthening India's sovereign debt market and enhancing the attractiveness of Indian Government Securities as a global investment asset class," said Rajeev Juneja, President of PHDCCI.

"By improving post-tax returns for foreign investors, the measure is expected to encourage greater participation in both the Fully Accessible Route (FAR) and the General Route, thereby broadening the investor base for government borrowing," he added.

The tax exemption is expected to complement existing market reforms by improving liquidity, deepening secondary market activity, and facilitating greater integration of India's bond market with global capital markets.

What Changes With the Amendment?

Under the amended framework, a new exemption has been introduced for "any interest on Government securities, and any capital gains arising from the sale, exchange, or transfer of such Government securities" earned by a foreign institutional investor (FII). The exemption has also been extended to the Bank for International Settlements (BIS).

Until now, FIIs were required to pay a 12.5% tax on long-term capital gains from government bonds held for more than 12 months, along with a withholding tax of 20% on interest income. Both taxes have now been scrapped.

Until July 1, 2023, the applicable tax rate on income from government securities, state development loans, and rupee-denominated bonds was 5%.

The 5% tax rate was originally introduced in 2013 to help curb the rupee's decline during the so-called "taper tantrum."

"It was intended to be a short-term measure, but the tax rate remained unchanged for over a decade. In 2023, the government decided to raise the tax rate on interest income from debt securities to 20% to align it more closely with the rates applicable to capital gains," Moneycontrol reported, citing an official.

The Finance Ministry said the exemption is aimed at facilitating investment in government securities and attracting foreign capital. Following the announcement, India's benchmark 10-year government bond yield fell to 6.95%. Bond prices and yields move in opposite directions.

"The tax exemption aligns India's sovereign debt market more closely with international best practices. Greater participation by long-term global investors can contribute to improved liquidity and stronger foreign exchange inflows in an increasingly interconnected global economy," said Ranjeet Mehta, CEO and Secretary General of PHDCCI.