P-notes may take hit on new tax treaties

Besides higher tax outgo, P-note issuers are worried about operational difficulties

With the new tax treaty with Singapore and Mauritius coming into effect from April 1, inflows through participatory notes (P-notes) could see a sharp drop.

According to Securities and Exchange Board of India (Sebi) data, nearly 90 per cent of P-note investments are routed through Singapore and Mauritius, with which the Indian government has reworked tax arrangements.

According to the changed double taxation anti-avoidance agreements (DTAAs), all investments made from these jurisdictions would attract short-term capital gains as the exemptions would get removed. 

Mauritius and Singapore are favoured by entities issuing P-notes-also called offshore derivative instruments (ODIs), thanks to tax-treaty benefits, particularly non-applicability of Indian laws.

The new treaty says that capital gains that arise from shares purchased after April 1 by foreign investors based in these countries can be taxed in India. Accordingly, a capital gains tax of at least 7.5 per cent can be charged on short-term gains from equity of investors from Mauritius and Singapore over the next two years and 15 per cent after that. Besides the higher tax outgo, issuers 

of P-notes are more worried about operational difficulties. 

Interestingly, Sebi, in a letter to finance ministry, has raised concerns over foreign portfolio investors (FPIs) reducing exposure in P-notes. 

Late last year, FPI body Asia Securities Industry and Financial Markets Association had warned that such tax changes could lead to a significant drop in flows. It had sought higher securities transaction tax instead of short-term capital gains tax-a demand that was not met in the Union Budget.

"The new changes could lead to lower returns to investors. The restructuring of tax benefits would make foreign investors re-evaluate the cost of compliance before taking this route," said Sudhir Bassi, partner, Khaitan & Co.

There is, however, a 50 per cent concession on the tax rate from April 1, 2017 to March 31, 2019, if the investors are able to show that they have a substantial presence in these countries. 

Investors will be taxed at the full domestic capital gains tax rate from 2019-20.

"The new treaty ensures genuine entry of investors and not investments through shell companies in tax havens. Now investments in India are not driven by tax exemptions but genuine appetite for Indian equities, which is doing really well despite global turmoil," said corporate lawyer H P Ranina.

Mauritius authorities are now equally concerned about tax evasion and are coming forward to increase transparency, he added.