Govt promulgates ordinance to exempt capital gains tax on FII investments in government securities

With an aim to attract foreign capital, the government on Friday promulgated an ordinance to exempt capital gains tax on investments made by Foreign Institutional Investors in government securities, according to a PTI report. The move is aimed at making Indian debt markets more attractive to overseas investors while helping shield the economy from the effects of the continuing Iran conflict.

The Union Cabinet, chaired by Prime Minister Narendra Modi, approved an ordinance on Wednesday to amend the Income Tax Act and facilitate the proposed exemption.

The government has issued the Income-tax (Amendment) Ordinance, 2026, providing tax relief to FIIs on both interest income and capital gains earned from investments in government securities.

Capital Gains Exemption for FIIs in government bonds

Published in the Gazette of India on Friday, the Ordinance introduces amendments to the Income-tax Act, 2025, and has been given retrospective effect from April 1, 2026.

Under the revised provisions, interest earned from government securities as well as capital gains arising from their sale, transfer, or exchange will be exempt from tax in the hands of foreign institutional investors.

The exemption is subject to certain compliance requirements. According to the Gazette notification, eligible investors will be required to furnish information in the prescribed format and manner to avail of the benefit.

The Ordinance also extends the same tax treatment to the Bank for International Settlements (BIS). As a result, any interest income or capital gains generated by the BIS from transactions involving government securities will likewise qualify for exemption.

In addition, a new Note 4 has been inserted to clearly define the entities eligible for the benefit. The amendment specifies that the term "Foreign Institutional Investor" will carry the meaning assigned under Section 210(6)(a) of the Income-tax Act, 2025.

The notification further clarifies that the expression "Government security" will have the same definition as provided under Section 2(f) of the Government Securities Act, 2006.

The measure is expected to improve the appeal of India's sovereign debt market among overseas investors by eliminating tax liabilities associated with investments in government securities.

Currently, foreign investors are subject to a 12.5% long-term capital gains tax on listed equities and bonds held for more than one year. Interest earned on government securities is also taxed through a 20% withholding levy. A concessional 5% tax rate that was previously available to foreign investors was withdrawn in 2023.

The government is also expected to introduce further initiatives designed to encourage overseas capital inflows.

The proposals come against a backdrop of sustained foreign fund outflows, with market participants repeatedly calling for lower long-term capital gains tax rates and reduced withholding taxes on interest income from government securities.

The timing is significant, as foreign portfolio investment flows have remained negative while the rupee has faced considerable pressure against the US dollar amid the continuing conflict in West Asia.

Since the start of the current calendar year, net FPI outflows have reached Rs 2.47 lakh crore, more than double the Rs 1.04 lakh crore withdrawn during calendar year 2025.

The rupee had weakened to a record low of 96.965 against the dollar on May 20 before recovering partially. The recovery was aided by RBI intervention and softer crude oil prices following renewed diplomatic efforts between the US and Iran.

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