India Exempts Foreign Institutional Investors from Tax on Government Securities

India has introduced a significant tax exemption for Foreign Institutional Investors (FIIs) and the Bank for International Settlements (BIS) concerning income earned from government securities. This move, enacted through the Income-tax (Amendment) Ordinance, 2026, aims to attract foreign capital, stabilize the Indian rupee, and deepen the country’s sovereign debt markets. The exemption, effective from April 1, 2026, covers both interest earned and capital gains from the sale or transfer of these government securities.

This policy change is a strategic effort by India to boost its financial markets by making them more attractive to overseas investors. By reducing the tax burden on specific types of investments, the government hopes to encourage greater participation from foreign entities. This can lead to increased liquidity in the debt market and potentially lower borrowing costs for the government.

Understanding the Tax Exemption

The exemption is specifically detailed within the Income-tax Act, 2025, through the insertion of serial numbers 13D and 13E in Schedule IV. These amendments clearly define the eligible entities as FIIs and the Bank for International Settlements. The exemption applies only when the eligible investor provides the required information in the prescribed format.

Crucially, this relief is narrowly targeted. It does not extend to all foreign investors or to Non-Resident Indians (NRIs) who are not classified as FIIs. The scope is limited to income derived solely from government securities, excluding other investment avenues such as equity shares, mutual funds, private bonds, corporate debt, or real estate.

Previous Tax Landscape for FIIs

Before this ordinance, FIIs typically faced taxation on their income and capital gains from securities under a special regime outlined in Section 115AD of the Income-tax Act. This framework imposed specific tax rates on income from securities and gains from their transfer. For instance, long-term capital gains on listed shares and bonds were taxed at a rate of 12.5%, while short-term capital gains were generally taxed at 30% or 15%/20% depending on the specific provisions and dates.

Furthermore, FIIs often could not claim standard benefits like indexation or foreign currency adjustments when calculating capital gains under Section 115AD. This meant the statutory tax rate played a more significant role in their investment decisions regarding Indian sovereign debt. The new exemption removes this tax friction, potentially improving the post-tax returns for eligible investors.

Economic Context and Motivations

The timing of this tax exemption is closely linked to current economic conditions. India has been experiencing pressure on its currency, the rupee, alongside global uncertainties and significant foreign capital outflows. Market reports indicated substantial net outflows from foreign portfolio investors in recent years, with the rupee reaching an all-time low against the U.S. dollar in May 2026.

By offering tax relief on government securities, India aims to incentivize overseas institutions to invest in its debt market. Such investments bring foreign currency into the country, which can help support the rupee. Additionally, a broader base of foreign investors for government borrowing can lead to greater market stability and potentially reduce the government’s borrowing costs over time.

Regulatory Support and Market Inclusion

This tax measure is not an isolated initiative. It complements other efforts by the Reserve Bank of India (RBI) to ease foreign access to the bond market. The RBI has been working to remove operational restrictions for foreign portfolio investments in government securities, including limits on short-term investments, concentration, and security-specific holdings.

The inclusion of Indian government securities in major global fixed-income indices has also increased their appeal. As large overseas funds often track these indices, a reduction in tax barriers makes it more attractive for them to increase their exposure to Indian debt. This combination of tax relief and regulatory easing addresses both financial and operational deterrents for foreign investors.

Impact on Currency and Market Stability

While the exemption is designed to be rupee-supportive, it is unlikely to guarantee a significant appreciation of the currency on its own. The rupee’s performance is influenced by a multitude of factors, including crude oil prices, the strength of the U.S. dollar, global economic sentiment, India’s trade balance, inflation, and interest rate policies.

However, the measure does provide overseas bond investors with a clearer and potentially more attractive post-tax return profile. This clarity can encourage more consistent investment flows, contributing to greater stability in the bond market and providing steady demand for the rupee. The government is betting that the benefits of increased foreign participation and a deeper sovereign debt market will outweigh the immediate loss of tax revenue.

Scope and Limitations of the Exemption

It is important to note that this ordinance does not establish a general tax holiday for all non-resident Indians or foreign investors. NRIs investing in assets like shares, mutual funds, real estate, or private bonds remain subject to existing tax rules unless they specifically fall under the FII or BIS categories and hold government securities.

The exemption is strictly confined to FIIs and the Bank for International Settlements, and only for specified income derived from government securities. Ordinary NRI tax obligations, including tax deducted at source and compliance requirements, remain in place. India has not abolished capital gains tax for all foreign investors, nor has it made gains from Indian equities or real estate automatically tax-free. This targeted approach ensures that the incentives are directed towards strengthening the sovereign debt market specifically.

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