Foreign investors are urging India to reconsider its decision to increase taxes on certain groups of wealthy portfolio investors, arguing the move will hit the competitiveness of Indian capital markets.

In the annual budget announced last week, Indian Finance Minister Nirmala Sitharaman proposed a tax increase of 3% for individuals with an annual income between 20 and 50 million rupees ($291,205-$728,014), and 7% higher tax for those earning more than 50 million rupees.

But Indian stocks slumped after the budget document's fine print revealed the new tax will also apply to foreign portfolio investors (FPIs) setup as trusts to invest in Indian markets.

Asset Managers Roundtable of India (AMRI), a lobby group of FPIs, said the higher tax could affect many large foreign mutual funds and pension funds, and hit India's reputation as a stable tax jurisdiction.

"This will certainly impact the competitiveness of the Indian capital markets," AMRI's President Nandita Agarwal Parker said in a letter to India's finance minister this week.

"There is no apparent basis to tax FPIs differentially based on their legal status," he added.

She urged the minister to seriously consider the move's impact on Indian capital markets, India's reputation as a stable tax jurisdiction and "the industry's ability to bring world class products and innovation to investors, aiding capital formation by attracting money to Indian equities, job creation, potential for export of services."

A finance ministry spokesman said he had no comment on the letter. The federal finance secretary S.C. Garg said at an event on Friday that the higher tax was aimed at "putting some extra responsibility" on the super-rich, and some of them happen to be FPIs.

About 40% of roughly 9,400 FPIs investing in India are registered as trusts, according to tax experts, while the rest are registered as corporates. Together, they have invested nearly $50 billion in Indian equity, debt and hybrid products.

AMRI's letter, reviewed by Reuters, said India's new tax structure would mean the effective peak rate of short-term capital gains tax on equity sales will be 21.37% for trust-based FPIs, compared to 16.38% for corporate FPIs.

The peak tax in case of capital gains on the sale of listed derivative products will increase from 35.88% to 42.74% on such FPIs, AMRI argued.

Eugenie Shen, head of asset management at Asia Securities Industry & Financial Markets Association, said high tax rates may discourage certain investors as these rates could be higher than in their home country.

"India has been doing a lot recently to make access easier for FPIs but this tax increase undermines these efforts," Shen told Reuters in an email. "It sends confusing messages to foreign investors."

Tax experts said if FPIs wish to switch from a trust-based model to a corporate one, it could have legal and tax implications in their home countries, and also raise the risk of violating general anti-avoidance rules in India that prevent entities from changing structures to avoid tax.