India's capital gains taxation framework for equity investments has undergone multiple transformations over the past three decades, reflecting changing policy priorities and market conditions. As Budget 2026 approaches, market participants are increasingly vocal about potential tax relief, particularly given persistent foreign investor selling and weak equity returns. Foreign institutional investors have sold over ₹1.6 lakh crore worth of Indian equities in 2025, with selling continuing into early 2026.

Understanding Capital Gains Classification

Capital gains represent the profit investors earn when selling assets like shares, mutual funds, or property at prices higher than their purchase cost. In equity markets, these gains are classified based on holding periods. Short-term capital gains (STCG) apply when listed shares are sold within one year of purchase, while long-term capital gains (LTCG) apply to shares held for more than one year.

The 1990s Framework

India's early approach to equity taxation in the 1990s featured a 20% tax rate on long-term capital gains, with indexation benefits available to investors. Indexation adjusts the asset's purchase price for inflation before calculating capital gains, effectively reducing taxable income by reflecting inflation's impact over time. During this period, short-term capital gains taxation did not exist as a concept.

The 2004 Paradigm Shift

A fundamental change occurred in 2004 when the government introduced the Securities Transaction Tax (STT) on equity trades while simultaneously abolishing long-term capital gains tax on listed equities held for more than one year. Short-term gains were taxed at a concessional rate, later standardized at 15%. This regime, lasting from 2004 to 2018, aimed to tax transactions rather than profits, simplifying compliance and encouraging broader market participation.

The tax-free LTCG period significantly deepened India's equity markets, leading to increased retail participation, growing mutual fund inflows, and enhanced foreign investor interest due to the absence of long-term capital gains taxation.

2018 Reintroduction and Subsequent Changes

The government reintroduced long-term capital gains tax in 2018, citing the need for greater tax equity and revenue mobilization. From April 1, 2018, long-term gains exceeding ₹1 lakh annually were taxed at 10% without indexation benefits. The government explicitly removed indexation benefits, opting for a flat tax rate on nominal gains.

Budget 2024 Adjustments

The Union Budget 2024 brought the most recent major changes, raising short-term capital gains tax from 15% to 20% and long-term capital gains tax from 10% to 12.5%. To mitigate impact on smaller investors, the exemption threshold for LTCG increased from ₹1 lakh to ₹1.25 lakh per financial year. However, indexation benefits remained unavailable.

Current Market Expectations

As Budget 2026 approaches, market participants are advocating for tax rationalization amid challenging market conditions. Key demands include:

• Reduction in LTCG or STCG rates
• Higher exemption thresholds for long-term gains
• Clarity on capital market reforms to improve post-tax returns

The current taxation structure requires investors to pay 20% on short-term capital gains and 12.5% on long-term capital gains exceeding ₹1.25 lakh annually, provided Securities Transaction Tax has been paid. While some investors hope for relief measures, others caution about potential fiscal implications of any tax rollbacks.

Tax policy experts have presented comprehensive recommendations for Budget 2026 to enhance India's mergers and acquisitions environment, particularly with the Income-tax Act, 2025 scheduled for implementation from April 1, 2026. The suggestions aim to address existing regulatory gaps and improve the ease of doing business for M&A transactions.

Fast-Track Demerger Tax Neutrality

A primary recommendation involves extending tax neutrality to fast-track demergers under Section 233 of the Companies Act, 2013. Currently, the Income-tax Act, 2025 provides tax neutrality only to NCLT-approved demergers under Sections 230 to 232, excluding fast-track demergers that enable small or closely held companies to undertake demergers without court approval.

The finance ministry's rationale for excluding fast-track demergers centers on concerns about potential valuation manipulation without court oversight. However, experts argue this approach contradicts the ease of doing business agenda, forcing genuine taxpayers to choose between transaction efficiency and tax benefits.

Contingent Consideration Clarity

Experts emphasize the need for clear taxation guidelines on earn-out, profit-linked, or contingent consideration arrangements that have become increasingly common in M&A transactions. These arrangements tie part of the sale consideration to achieving specific profitability or financial milestones.

The current legal framework lacks clarity on:

• Taxability of contingent payments
• Timing of taxation for such arrangements
• Treatment of milestone-based considerations

Foreign Company Merger Anomalies

The recommendations address existing inconsistencies in foreign company merger taxation. While foreign companies enjoy capital gains tax exemptions on direct or indirect share transfers during mergers with other foreign companies, shareholders of the amalgamating company face potential capital gains liability on share swaps.

This creates an anomaly compared to domestic mergers, which provide exemptions at both company and shareholder levels.

Capital Gains Tax Rate Concerns

The recent capital gains tax regime rationalization introduced higher long-term capital gains tax rates, which experts suggest adversely impacts investor returns and exit efficiency. The increased rates potentially drive investors toward jurisdictions with more favorable tax regimes.

Key concerns include:

• Reduced post-tax returns for investors
• Decreased competitiveness with other investment destinations
• Impact on foreign capital attraction

Experts recommend reducing capital gains tax rates, suggesting restoration of the earlier 10.00% rate to improve India's competitive position in attracting foreign investment.

Strategic Implementation Timeline

With the Income-tax Act, 2025 set for April 1, 2026 implementation, Budget 2026 represents the final opportunity to incorporate these amendments before the new framework takes effect. The recommendations aim to position India as a preferred destination for cross-border M&A activities while maintaining regulatory integrity and supporting corporate growth objectives.