Morgan Stanley shifts p-note base as govt tightens rules for FPIs

India's largest p-note issuer moves from Singapore to France; changes to Indo-Mauritius tax treaty could have triggered shift

Morgan Stanley, India’s largest participatory notes (p-note) issuer, has shifted its operations from Singapore to France amid changes to the Indo-Mauritius tax treaty. According to sources, all the p-notes issued by the American brokerage starting from January 1, 2018 will be coming through France route instead of Singapore. However, the Morgan Stanley has not shut-down its Singapore operations as a substantial amount of p-notes it has issued from that jurisdiction are still active and transferring these instruments to a different location could trigger tax provisions of indirect transfers. 

This shift by Morgan Stanley comes even as the Indian government has tightened the policy framework around foreign portfolio investors (FPIs) selecting a jurisdiction purely based on tax reasons. Morgan Stanley has gone ahead with the movement even as another top foreign brokerage red-flagged the issue with the Finance Ministry in August 2016. The development brings forth several loopholes in the current regulations including the newly implemented General Anti-Avoidance Rules (GAAR). 

According to data compiled by the market regulator Securities and Exchange Board of India (Sebi) in 2016, Morgan Stanley Singapore is the largest p-note issuer in the country with a market share of 14.3 per cent followed by J P Morgan Mauritius with a share of 11.2 per cent. 

“Given the new terms of Indo-Mauritius DTAA, it is a rational decision from business point of view for Morgan Stanley. Although such a transition is majorly based on tax concerns, there is nothing much the Indian authorities could do as Morgan Stanley has enough establishments in France to suffice all the conditions of GAAR,” said a source privy to the development. 

Top five p-note issuers in India
Name	Country	Market share (%)
Morgan Stanley	Singapore	14.4
Copthall Investments	Mauritius	11.3
Goldman Sachs	Singapore	9.2
Credit Suisse	Singapore	7.6
Merill Lynch	Spain	5.4
Source: Sebi

GAAR provisions empower the Indian authorities to declare an arrangement as an 'impermissible avoidance arrangement,' if the main purpose of the agreement is to obtain a 'tax benefit'. However, in order to decide if an arrangement is for tax benefit or not, taxmen rely on tests like commercial substance. These tests take into consideration the establishment, set-up, employees and business activities of the firm in the new jurisdiction while to arrive at a conclusion. Firms like Morgan Stanley can easily fulfill these conditions as they have pan-global presence and also have permanent establishments across the major global markets including France. 

“GAAR gives considerable power to Indian authorities to penalize the investors who choose a jurisdiction solely based on tax considerations. Having said that, about half a dozen big FPIs which have a pan-global presence might still be able to manage such a movement, as they have establishments around the world,” said Tejesh Chitlangi, partner, IC Universal Legal. 

The government has also signed multi-lateral instruments (MLIs) as a part of OECD Base erosion and profit shifting (BEPS) convention to further tighten the policy framework around tax evasion by foreign institutions and multi-national companies (MNCs). The instruments are aimed at institutions who avoid tax through the strategic use of cross-border shifting of profits. 

Although conditions under MLIs are relatively stringent compared to domestic anti-avoidance rules, invoking MLIs does not seem to be an option for the government at this point as there are still plenty of uncertainties around the framework. To begin with, MLIs don’t have the complete legal status yet and in order to provide legal sanctity, government will have to tweak several acts including the Income Tax Act. Also, MLIs are monitored through Organisation for Economic Co-operation and Development (OECD) an intergovernmental organisation. Hence, until all the signatories make necessary changes to their domestic laws, extent of enforceability of these agreements remains unclear, tax experts said. 

Several top foreign institutions investing in India through Mauritius and Singapore route have been mulling a shift from these jurisdictions ever since the Indian government renegotiated the tax arrangements with these countries. Until March 2016, FPIs based out of Mauritius and Singapore used to pay zero capital gains tax due to the DTAA. Under the new agreement, they would be subject to 15 per cent tax on short-term capital gains (sale of shares held for less than one year). India doesn’t charge long-term capital gains (equity assets held for more than a year) tax for any class of investors. Countries like Netherlands, France and Luxembourg provide tax incentives to FPIs on par with what Mauritius and Singapore do. However, funds use to prefer the latter route due to lesser compliance costs and lenient domestic laws.