After 2017, when Mauritius lost some of its charm as a tax haven, P-note trade began to flourish in Paris as leading French banks sold the instrument. This could now change if revisions to the treaty remove France’s serious tax advantage compared to other jurisdictions.
Although the government is yet to release the revised treaty, the word on the street is that India would now have the right to tax all equity sales by French investors.
P-notes are offshore derivative instruments having Indian equities as underlier and are issued by foreign portfolio investors (FPIs) registered with the Securities & Exchange Board of India (Sebi). Traditionally, overseas investors who want to trade in Indian stocks but prefer anonymity and minimum paperwork, invested in P-notes.
How’s France different?
Investors from Mauritius and Singapore pay tax on profits from sale of Indian equities bought on or after April 1, 2017, following amendments in the respective treaties with the two countries. However, an FPI from France holding less than 10% in a company pays no tax on capital gains from stock sale. Since an FPI’s stake in a company cannot cross 10%, FPIs from France had a distinct advantage – direct as well as P-note investors paid no tax on gains from stock sale.
Pick The Netherlands, Belgium?
“If the 10% beneficial threshold under India-France treaty is removed, investing under P-note route via a French broker dealer will no longer be attractive from a tax perspective because the French broker dealer or P-note issuer will now be liable to capital gains tax in India. This will place the French treaty on par with India’s treaties with Singapore, Mauritius, Ireland etc,” said Rajesh Gandhi, partner, Deloitte India. This would also impact other FPIs from France investing in India, he said. The share of P-notes declined from over 40% two decades ago to below 2% of FPI investments, partly due to stricter disclosure rules. Still, many foreign investors find it handy. While India’s treaties with The Netherlands and Belgium offer similar benefits, it’s not possible to relocate overnight P-note issuers from Paris to Amsterdam or Brussels. The amendments could therefore force French FPIs to stop P-note sales or change strategy.
“It would impact P-note marketability by French FPI intermediaries which typically compete on thin margins,” said Parul Jain, who heads the international tax practice at the law firm Nishith Desai Associates. “Taxes applicable on return from securities are embedded into the returns/pricing for the P-notes and hence passed on by FPIs to P-note holders. The proposed change to remove capital gains exemption and raise dividend taxation will make investments through P-notes more expensive, particularly given the limited ability for P-note holders to claim tax credits in the home country,” said Jain.
The revised treaty is expected to halve the withholding tax on dividend to 5% for French companies holding more than 10% in an Indian entity but raise the tax to 15% for shareholders with less than 10% stake.
MFN clause reset
The proposed changes, some feel, aim to address issues around the most favoured nation (MFN) clause in treaties. “The Supreme Court in Nestle SA clarified that the MFN clause cannot be automatically invoked unless the beneficial provision is specifically notified. The ruling effectively curtails the ability of certain jurisdictions, including France, to claim a lower dividend withholding tax rate or tax exemption on fees for technical services in the absence of a ‘make available’ clause. Thus, the proposed amendments, including lower tax on dividend for higher stakeholders, appear to be a calibrated response,” said Ashish Karundia of Ashish Karundia & Co.
“From a structuring standpoint, this may prompt some FPIs to reassess their jurisdictional exposure to France. Investors may examine the treaties with Netherlands and Belgium, which continue to provide capital gains protection for sub-10% holdings. However, any restructuring must satisfy robust commercial rationale and substance requirements to legitimately access treaty benefits, particularly after the Supreme Court ruling on Tiger Global and anti-abuse standards,” said Karundia.