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

15 May 2026

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.

About Foreign Portfolio Investors (FPIs)

Foreign Portfolio Investors are overseas investors who invest in financial assets such as shares, bonds and securities in another country.
Eligible Investors: Foreign institutional investors, pension funds, sovereign wealth funds, insurance companies, mutual funds and asset management firms.
Regulatory Authority: In India, FPIs are regulated by Securities and Exchange Board of India under the SEBI (FPI) Regulations.
Nature of Investment: FPIs invest in listed securities without seeking management control, unlike Foreign Direct Investment (FDI).
Importance: FPIs enhance capital availability, improve market liquidity and strengthen integration of Indian financial markets with global markets.

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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