Tax-Free Government Securities for FIIs: Key changes by Income-tax (Amendment) Ordinance, 2026

Tax-Free Government Securities for FIIs: Understanding the Income-tax (Amendment) Ordinance, 2026

Introduction

The Government of India has recently introduced the Income-tax (Amendment) Ordinance, 2026, bringing significant tax relief for Foreign Institutional Investors (FIIs) investing in Government Securities (G-Secs). Under this amendment, both interest income and capital gains arising from specified Government Securities have been exempted from income tax for eligible FIIs. The exemption is effective from April 1, 2026.

The announcement has attracted considerable attention from financial markets, economists, and investors. The move reflects the Government’s broader objective of attracting foreign investment, strengthening the bond market, and reducing the cost of borrowing.

This article discusses the key provisions of the amendment, its expected benefits, and its implications for India’s economy and financial markets.

Understanding Government Securities

Government Securities, commonly known as G-Secs, are debt instruments issued by the Central Government to borrow funds from the market. These securities are considered among the safest investment options because they carry the sovereign guarantee of the Government of India.

Government Securities include:

• Treasury Bills (T-Bills)
• Government Bonds
• Dated Securities
• Sovereign Green Bonds

Investors who purchase Government Securities earn interest on their investments and may also earn capital gains if the value of the securities increases before maturity.

G-Secs play a crucial role in financing government expenditure, infrastructure development, and public welfare schemes.

Who are Foreign Institutional Investors (FIIs)?

Foreign Institutional Investors are entities established outside India that invest in Indian financial assets such as equities, bonds, and Government Securities.

Examples include:

• Pension Funds
• Insurance Companies
• Sovereign Wealth Funds
• Asset Management Companies
• Investment Funds

FIIs contribute significantly to market liquidity and help bring foreign capital into the Indian economy. Their investment decisions often influence market sentiment and capital flows.

In recent years, India has taken several steps to encourage foreign participation in the debt market. The latest tax exemption is another important initiative in this direction.

Key Features of the Income-tax (Amendment) Ordinance, 2026

The Ordinance introduces important tax benefits for FIIs investing in Government Securities.

1. Exemption of Interest Income

Interest earned by eligible FIIs from specified Government Securities will now be exempt from income tax.

Prior to this amendment, such interest income was generally subject to taxation, reducing the effective return earned by foreign investors.

The exemption increases the post-tax return available to FIIs and makes Indian Government Securities more attractive.

2. Exemption of Capital Gains

The amendment also exempts capital gains arising from investments in eligible Government Securities.

Capital gains occur when securities are sold at a price higher than their purchase cost.

The removal of capital gains tax significantly improves investment returns and encourages long-term participation by foreign investors.

3. Effective Date

The tax exemptions are applicable from April 1, 2026.

Investments covered under the notified framework will be eligible for the benefits from the specified date.

4. Similar Benefit to BIS

The Bank for International Settlements (BIS) has also been granted similar exemptions on interest income and capital gains arising from Government Securities.

This reflects India’s intention to align with international practices and encourage participation by global financial institutions.

Position Before and After the Amendment

The impact of the amendment can be understood through a simple comparison:

The removal of tax liability directly increases the returns earned by FIIs, making Indian Government Securities more competitive compared to similar instruments available in other countries.

Why Has the Government Introduced This Exemption?

The decision is not merely a tax concession. It is a strategic policy measure aimed at strengthening India’s financial markets.

1. Increasing Foreign Investment

Foreign investors compare investment opportunities across multiple countries.

Taxation often plays an important role in investment decisions. By removing tax on interest and capital gains, India becomes a more attractive destination for global capital.

Higher foreign investment can help increase liquidity and improve market efficiency.

2. Deepening the Bond Market

India’s bond market remains smaller than many developed economies.

A larger and more active bond market provides several advantages:

• Better price discovery
• Greater liquidity
• Lower borrowing costs
• Improved financial stability

The tax exemption may encourage more international participation and contribute to the development of a deeper bond market.

3. Supporting Government Borrowing

The Government regularly raises funds through Government Securities to finance expenditure and development projects.

If more investors are willing to purchase G-Secs, demand increases.

Higher demand generally results in lower borrowing costs for the Government, which can reduce interest expenditure over time.

4. Aligning with Global Practices

Many countries provide favorable tax treatment to foreign investors in government debt instruments.

The latest amendment helps India remain competitive in attracting international capital and aligns the country’s tax framework with global standards.

Expected Impact on Various Stakeholders

1.Impact on FIIs

Foreign investors are likely to be the biggest beneficiaries.

The exemptions increase post-tax returns and improve the overall attractiveness of Indian Government Securities.

This may encourage both existing and new investors to increase their exposure to India’s debt market.

2.Impact on the Government

The Government may benefit from increased demand for Government Securities.

Higher demand can result in:

• Lower borrowing costs
• Better subscription of government debt
• Increased investor confidence

Although there may be some loss of tax revenue, policymakers may consider it a worthwhile trade-off for attracting larger capital inflows.

3.Impact on RBI

A deeper and more liquid bond market can improve the effectiveness of monetary policy transmission.

The Reserve Bank of India can benefit from a more efficient debt market while managing liquidity and interest rates.

4.Impact on Domestic Investors

Domestic investors may experience indirect benefits through improved market liquidity and more efficient pricing of securities.

However, some may argue that foreign investors are receiving preferential treatment compared to domestic investors who continue to pay taxes on certain forms of investment income.

Possible Concerns and Challenges

While the amendment offers several advantages, certain concerns may also arise.

1. Revenue Loss

The Government will forgo tax revenue that would otherwise have been collected from FIIs.

Whether the resulting increase in foreign investment compensates for this revenue loss will depend on future market participation.

2. Unequal Tax Treatment

Some stakeholders may question why foreign investors receive exemptions that are not available to all domestic investors.

Policymakers may need to address concerns regarding fairness and neutrality in taxation.

3. Dependence on Foreign Capital

Greater participation by foreign investors can increase capital inflows, but excessive dependence on foreign funds may also expose markets to volatility during periods of global uncertainty.

Therefore, maintaining a balanced investor base remains important.

4. Need for Regulatory Safeguards

Authorities must ensure that the exemption is not misused through tax avoidance arrangements or artificial structures designed solely to claim benefits.

Appropriate compliance and monitoring mechanisms will be essential.

Long-Term Significance for India

The amendment should be viewed as part of India’s broader strategy to modernize and strengthen its financial markets.

A stronger bond market can:

• Support infrastructure financing
• Improve capital allocation
• Reduce dependence on bank lending
• Attract global investors
• Enhance financial stability

As India aims to become one of the world’s largest economies, access to diversified sources of capital will become increasingly important.

The tax exemption can help position India as a preferred destination for international debt investors and support long-term economic growth.

Conclusion

The Income-tax (Amendment) Ordinance, 2026 marks an important policy initiative aimed at attracting foreign investment into Government Securities. By exempting both interest income and capital gains earned by FIIs, the Government has significantly improved the attractiveness of India’s sovereign debt market.

The measure is expected to deepen the bond market, enhance liquidity, increase foreign participation, and potentially reduce government borrowing costs. At the same time, policymakers will need to carefully balance the benefits of attracting capital against concerns relating to revenue loss and tax equity.

Overall, the amendment represents a significant step towards strengthening India’s financial markets and integrating them more closely with global investment flows. If implemented effectively, it could contribute meaningfully to India’s long-term economic and financial development.