The case for a level tax playing field between equity and debt

The debate on easing long-term capital gains tax on equity investments began with the massive pullout by foreign portfolio investors (FPIs). It has since widened to include the possibility of reducing capital gains tax on equity investments across the board, for both foreign and domestic investors.

The argument is that, before 2018, long-term capital gains on equity investments held for one year or longer were exempt from tax. The Union budget of 2018 introduced a 10% tax, which has since risen to 12.5%, plus surcharge and cess, as applicable.

The debt disadvantage

In debt mutual funds, a staple investment vehicle for bonds and other instruments, capital gains are taxed as short-term capital gains, irrespective of the holding period. The tax is levied at the investor’s marginal slab rate. For some investors, such as those in the early stages of their careers or retired senior citizens, this rate may be lower. However, for most investors who are doing well financially, it is the highest slab rate of 30%, plus surcharge and cess, as applicable.

The dividend option of mutual funds, known as the Income Distribution cum Capital Withdrawal (IDCW) option, is also taxable at the marginal slab rate. In listed bonds, however, long-term capital gains tax of 12.5% applies to holdings of more than one year. But most of the income from bonds comes from the coupon (interest), which is taxable at the marginal slab rate. Thus, debt mutual funds and direct bond investments face a significant tax disadvantage compared with equity investments.

Earlier, indexation was available for long-term capital gains on debt mutual funds, reducing the effective tax rate. That benefit is no longer available. Gains are now taxed entirely at the marginal slab rate.

In equity mutual funds, the Equity Linked Savings Scheme (ELSS), or Tax Saver Fund, qualifies for a deduction under Section 80C of the Income-tax Act, now Section 123 of the Income-tax Act, 2025. This benefit is available under the old tax regime, although most taxpayers have shifted to the new regime. Either way, the fact that such a benefit is available for equity investments shows that the government is incentivising investment in equity, rather than debt. Debt investments, which are relatively more stable in performance, have an equally strong case for favourable tax treatment.

Debt funds growth

It may be argued that equity investors take on greater risk because returns are more uncertain and volatile. But equity has also delivered higher returns than debt over long periods. Another argument is that, as a growing economy, India needs growth capital, and equity provides it. In a corporate balance sheet, equity is the risk or ownership capital. From that perspective, debt capital is equally significant in funding corporate growth.

As of 30 September 2026, outstanding corporate bonds amounted to ₹61.5 lakh crore. Add bank loans, and debt represents a major source of funding for corporate balance sheets. As of 31 August 2026, bank loans to industry, from micro to large enterprises, stood at ₹48 lakh crore, while loans to services, including trade and transport, among others, amounted to ₹63 lakh crore.

In our mind-frame, equity occupies a bigger share because we think in terms of market capitalization. The market capitalization of listed companies is approximately ₹487 lakh crore, but that is not the amount that has gone into building corporate balance sheets. Market capitalization is calculated using stock prices, which are usually multiples of the face value of shares. Hence, only a fraction of this ₹487 lakh crore has actually been raised by corporates.

A wider debate

Equity investors are incentivised by the government through a relatively lower tax rate of 12.5%, compared with the marginal slab rate applicable to debt investments. Equity also presents the more visible aspect of growth capital, as investors see their wealth grow through this asset class.

The equity market has delivered no returns over the past two years, with selling by FPIs being a major reason. This has fuelled the debate, which was further bolstered by positive feelers from the finance minister. Yes, there is a case for lowering capital gains tax on equities. But why treat debt capital as a poor, distant cousin?

For investors, nothing changes at this point. The discussion remains at the proposal and deliberation stage. If a change is implemented, either in the next Union budget, to be announced on 1 February 2027, or earlier through an Ordinance, that could become a point of decision-making for investors.

Joydeep Sen is a corporate trainer (financial markets) and author.