The NSE Nifty fell about 1 percent on Monday to a seven-month low, erasing its gain for the year, as investors fretted that the government may impose long-term capital gains tax.
Prime Minister Narendra Modi said on Saturday that people in financial markets must make a "fair contribution" to nation building, comments that were seen as setting up the prospect of higher taxes for investors.
However, Finance Minister Arun Jaitley clarified on Sunday that the government did not plan to impose long-term capital gains tax, though that was not enough to prevent selling on Monday.
Indian shares were headed for an eighth session of declines in nine amid worries about outflows from emerging markets to the United States and continued concerns about India's move to ban higher-value currency notes.
"It (reaction to PM's comments) is a knee-jerk reaction," said Gaurang Shah, vice president, Geojit BNP Paribas.
"The fact that we have broken certain levels since Brexit day low, could be spooking markets further."
The Nifty fell as much as 1.15 percent to 7,893.80, its lowest since May 25. It has erased its gain for the year and was last down about 0.5 percent for the year.
The index was down 0.97 percent at 7,908.45 as of 0621 GMT on Monday.
The benchmark Sensex was 0.87 percent lower at 25,814.75 after falling as much as 1.1 percent to its lowest since Nov. 21 earlier in the session.
In another sign of nerves in markets, the NSE's India Volatility index surged 8.3 percent.
Banking stocks fell, with HDFC Bank and ICICI Bank among the biggest contributors to the decline.
The NSE Bank index fell as much as 1.55 percent to its lowest since June 29.
Consumer and material stocks also dragged down the indexes with the Nifty Metal index shedding as much as 2.80 percent to its lowest in over a month.
(Reporting by Tanvi Mehta in Bengaluru; Editing by Subhranshu Sahu)