SEBI has reportedly proposed tax relief for domestic mutual fund investors ahead of Budget 2027. The proposal aims to exempt investors from long-term capital gains tax when switching investments. Financial experts note that removing this tax could increase investor interest, although it may impact government revenues.
According to an ET report, the Securities and Exchange Board of India (SEBI) has reportedly proposed tax relief for domestic mutual fund investors. Under the proposal, investors would be exempted from long term capital gains (LTCG) tax when selling existing holdings to invest in new ones. SEBI has sent this as a pre-budget proposal to the government ahead of Budget 2027. It is up to the Finance Ministry to accept this proposal or implement it in some other way.
However, SBI estimates that abolishing LTCG could reduce government revenue by Rs 40,000–50,000 crore.
At present, selling a mutual fund after 12 months attracts 12.5% LTCG tax. Selling if within 12 months attracts 20% short term capital gains (STCG) tax. This tax also applies while switching from one fund to another. For example, if you invest in a small cap mutual fund and want to switch to a large cap mutual fund after 13 months, it will trigger 12.5% LTCG tax. If the government accepts the SEBI proposal, it will mean that 12.5% LTCG will not be applied at the time of the switch.
Can this proposal be accepted by the government in Budget 2027?
Suresh Sadagopan, founder, Ladder7 Financial Advisories, says that it would be very difficult for the government to implement this suggestion. Crude oil prices are rising, petrochemical inputs are becoming more expensive and rainfall deficit may require the government to support the agriculture sector in various ways. Removing the LTCG tax will help investors earn more but it will also reduce the government's tax revenue. This could be especially difficult when the external environment is not supportive and the government support may increase the fiscal deficit.
Aarti Raote, Partner, Deloitte India, said to ET Wealth Online that investor groups have long urged the government to consider reducing capital gains tax rates, arguing that a 12.5% tax on capital gains, coupled with Securities Transaction Tax (STT) and taxation on dividends, significantly erodes post-tax investment returns.
However, if the objective is to revive investor interest, it is debatable whether a reduction in tax rates alone would be sufficient. Raote says any proposal to lower tax rates has to be evaluated carefully from a fiscal perspective, given the substantial tax revenues generated from capital gains.
Raote says: "Policymakers will therefore need to strike a balance between enhancing the attractiveness of Indian markets and safeguarding government revenues."
Naitik Doshi, Director-Financial Services, Nangia Global, pointed out to ET Wealth Online that there is a reasonable possibility of the Finance Ministry considering the proposal in Budget 2027. The mutual fund industry has consistently sought rationalisation of capital gains taxation to encourage long-term investments and greater domestic investor participation.
In its Budget 2026–27 recommendations, the Association of Mutual Funds in India (AMFI) proposed a differentiated capital gains tax regime based on the holding period, suggesting a 12.5% tax on gains exceeding Rs 2 lakh for investments held between one and three years, with complete exemption for investments held beyond three years. Doshi says this reflects the industry's objective of incentivising longer holding periods and encouraging household savings to remain invested in domestic capital markets.
Doshi says: "While the government will need to balance these proposals against revenue considerations and the broader objective of maintaining consistency across the taxation of different asset classes and investment avenues, SEBI's latest proposal provides an opportunity to revisit the existing framework and make it more rational, predictable and investor-friendly."
Vishal Lohia, Partner, Dhruva Advisors, said to ET Wealth Online that the SEBI's proposal (as reported) to exempt mutual fund scheme switches from Long-Term Capital Gains (LTCG) tax is an encouraging proposal that will certainly be evaluated by the Finance Ministry for Budget 2027.
Currently, when an investor switches from one scheme to another to rebalance their portfolio, it is treated as a redemption and a fresh purchase, triggering an immediate tax liability. Lohia says that this friction often discourages retail investors from actively managing their asset allocation in response to changing life goals or market cycles.
According to Lohia, the Finance Ministry has consistently focused on encouraging disciplined, long-term retail participation in the capital markets. Allowing tax-neutral switches aligns perfectly with this vision, as the investor's capital remains deployed within the financial ecosystem rather than being cashed out.
Lohia says: "While the Ministry will carefully weigh this against potential revenue impact and the principle of tax parity across asset classes, the proposal has strong merit. It promotes responsible portfolio management and reduces the compliance burden on everyday investors."
How could the government implement this proposal?
Doshi says that the government should favour a targeted approach rather than a blanket exemption. The objective should be to incentivise long-term investments while providing investors with greater flexibility to manage and rebalance their portfolios.
Doshi says that there is merit in AMFI's recommendation to provide differentiated tax treatment based on the holding period, with greater incentives for investments held beyond three years. This would reward patient investors and encourage long-term capital formation.
At the same time, any changes to the capital gains tax framework should be consistent across equity investments, whether made directly through listed shares or through equity mutual funds.
Doshi says: "The tax treatment should ideally be based on the underlying asset and holding period rather than the investment route, avoiding unintended tax arbitrage."
Another important aspect is tax-neutral switching. Doshi says that while AMFI has highlighted this for intra-scheme switches, SEBI's proposal to extend the benefit to switching between eligible mutual fund schemes would provide investors greater flexibility to rebalance portfolios without triggering an immediate tax liability, provided the money remains invested within the mutual fund ecosystem.
Experts say that the government should aim for a simpler, clearer and more consistent capital gains tax regime, combining long-term investment incentives with tax-neutral switching, rather than introducing multiple exemptions and special provisions.
CA Avinash Kumar Rao, Partner at Mohindra & Associates, says that the government should allow investors to switch between eligible mutual fund schemes without triggering immediate capital gains tax, provided the entire redemption proceeds are reinvested within a prescribed period, say 30 days.
