Withholding Tax: Boosting Foreign Investment in India’s Bond Market

The Government is considering reducing withholding tax on government bonds to attract foreign investments and stabilise India’s external financial position.

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About Withholding Tax

• Withholding tax refers to tax deducted at source on payments such as interest, dividends, royalties or bond income made to non-residents.
• Tax Collection Mechanism: The payer deducts tax before making payment and deposits it directly with the government, ensuring timely tax collection and compliance.
• Higher Tax on Non-Residents: Foreign investors such as FPI currently pay nearly 20% withholding tax on interest earned from Indian government bonds after concessional rates (5%) ended in 2023.
• Relation with TDS: In India, Tax Deducted at Source (TDS) generally applies to domestic transactions, while withholding tax mainly applies to cross-border payments.
• Role of DTAA: Double Taxation Avoidance Agreements (DTAAs) allow investors from partner countries to avail lower withholding tax rates.

Need for Reducing Withholding Tax

• Improve Foreign Capital Inflows: High withholding tax creates investment friction and discourages foreign portfolio investment into Indian debt markets.
  • Foreign Portfolio Investors withdrew nearly $22.5 billion from Indian financial markets in 2026 amid global uncertainty.
• Strengthen Forex Reserves: India is attempting to conserve foreign exchange reserves amid rising oil prices, West Asia tensions and rupee depreciation pressures.
  • RBI’s interventions and external account pressures have increased concerns regarding reserve adequacy.
• Enhance Global Competitiveness: India’s withholding tax remains among the highest globally compared to:
  • China: 10% with exemptions
  • Vietnam: 5%
  • Malaysia: Government bonds exempted.
• Support Bond Market Development: Lower tax burdens can increase foreign participation in government securities and deepen India’s domestic bond market ecosystem.

Potential Impact of Reducing Withholding Tax

• Higher Foreign Investment: Lower withholding tax may improve returns for foreign investors and attract greater inflows into Indian government bonds and debt markets.
• Stabilisation of Rupee: Increased foreign capital inflows can strengthen forex reserves and reduce excessive volatility in the rupee exchange rate.
• Lower Government Borrowing Costs: Greater demand for government bonds may reduce bond yields, lowering borrowing costs for the government and improving fiscal management.
• Improved Investor Confidence: Tax reforms signalling a stable and investor-friendly environment can enhance India’s attractiveness as a long-term investment destination.

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Conclusion

Reducing withholding tax can improve India’s investment attractiveness, but long-term capital inflows will depend on macroeconomic stability and policy credibility.

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