India : Participatory notes back after amended tax treaties, GAAR bring laws close to international norms

MUMBAI: Participatory notes are back in favour since amended tax treaties and GAAR (General Anti Avoidance Rules) brought Indian laws closer to international compliance norms with effect from April 1, reports Economic Times.

P-notes are overseas derivative instruments with Indian stocks as their underlying assets. The increasing interest in P-notes is also the result of many banks or prime brokers—about 13 of them based in Europe and the US—launching and aggressively marketing several P-note products to attract investors, said bankers, custodians and tax consultants aware of the matter.

Investments in domestic capital markets through P-notes slumped to the lowest in nearly two years to Rs 2.10 lakh crore at the end of June last year after the Securities and Exchange Board of India (Sebi) tightened disclosure norms and other rules. The revival in interest stems from investments through vehicles registered in Mauritius and Singapore coming under the scrutiny of regulators and being vulnerable to additional taxes due to GAAR, which is aimed at curbing tax evasion by foreign and domestic investors. Since then, many foreign portfolio investors (FPIs) have been taking fresh positions on India through P-notes, said market players.

"Some investors might be tempted to invest through the P-note route to get treaty benefits on equity and derivative gains. However, one needs to keep in mind the additional cost, which could be incurred by using the P-note route," said Rajesh H. Gandhi, partner, Deloitte Haskins & Sells. An executive of a French bank that offered one such P-note product said many investors who had not shifted to P-notes till March have been doing so since April 1.

"We are indemnifying our P-note investors that GAAR shall not apply on their investments," the executive told ET. The government has said that GAAR won’t apply to P-note subscribers, experts said. Still, this doesn’t mean there are no curbs. "The P-note issuers are offering different variants of the P-note products to investors. Not all investors coming through the P-note route may pass the GAAR test, if they invest directly in India," said Suresh Swamy, partner, PwC.

A Switzerland-based prime broker has been offering a product where losses made in equities and derivatives can be adjusted. "Tax of about 7-8 per cent would then be paid on net positions," the person said.

There are several such products being offered by prime brokers. A similarly tailored product offered by a New York-headquartered investment bank includes sops tied to exchange gains.

"There are other distinctive features of using the P-note route such as loss of tax credits and loss of carry forward, multiple counter party risks etc. The impact of these differences should be analysed before making a decision," said another person advising an FPI making a shift.

Until March 31, many FPIs invested in India through investment vehicles registered in tax havens such as Mauritius, Singapore and Cyprus. The government amended treaties with these countries and now tax will be levied on short-term capital gains on all investments made through these vehicles beginning April 1.

If FPIs are unable to justify that these destinations are not used for tax benefits but are real operational bases, there could be additional taxes under GAAR. This has also resulted in a conflict between the tax consultants and custodians. ET reported Monday that custodians, mainly foreign banks, want a certificate from consultants such as the big four firms stating that GAAR is not applicable to their clients.

The consultants on their part are reluctant to provide such a certificate. It is expected that the number of investments in India through P-notes could rise in April. That could be followed by additional regulations from Sebi or the income tax department.



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