India-France tax shift threatens P-note trade
After 2017, when Mauritius lost some of its appeal as a tax haven, P-note trading began to flourish in Paris, with leading French banks selling the instrument. This could change if revisions to the agreement eliminate France’s significant tax advantage over other jurisdictions.
While the government is yet to publish the revised agreement, India is said to now have the right to tax all stock sales by French investors.
P-notes are offshore derivative instruments based on Indian equities and are issued by foreign portfolio investors (FPIs) registered with the Securities and Exchange Board of India (Sebi). Traditionally, overseas investors who wanted to trade Indian stocks but preferred anonymity and minimal paperwork invested in P-notes.
What is different about France?
Investors in Mauritius and Singapore pay tax on profits from the sale of Indian shares purchased on or after April 1, 2017, following amendments to relevant agreements with the two countries. However, an FPI from France that holds less than a 10% stake in a company does not pay tax on capital gains from the sale of shares. FPIs in France had a distinct advantage, as an FPI’s stake in a company could not exceed 10%; Both direct and P-note investors did not pay taxes on gains from the sale of shares.
Do you choose Netherlands or Belgium?
“If the 10% gain threshold under the India-France deal is removed, investing under the P-note route through a French broker dealer will no longer be attractive from a tax perspective as the French broker dealer or P-note issuer will now be subject to capital gains tax in India. This will bring the French deal on par with India’s deals with Singapore, Mauritius, Ireland, etc,” said Rajesh Gandhi, partner at Deloitte India. He said this will also impact France’s other FPIs investing in India. The share of P-notes has fallen from 40% two decades ago to less than 2% of FPI investments, partly due to tighter disclosure rules. Still, many foreign investors find it useful. While India’s agreements with the Netherlands and Belgium offer similar benefits, it is not possible for P-note exporters to move from Paris to Amsterdam or Brussels overnight. The changes could therefore force French FPIs to stop selling P-notes or change their strategies.
“This will impact the marketability of the P rating for French FPI brokers, who typically compete on low margins,” said Parul Jain, who heads the international tax practice at law firm Nishith Desai Associates. “Taxes on returns on securities are included in the returns/pricing of P-notes and hence passed on to P-note holders by FPIs. The proposed amendment to remove capital gains exemption and increase dividend taxation will make investments through P-notes more expensive, especially given the limited ability of P-note holders to claim tax credits in their home countries,” Jain said.
The revised agreement is expected to halve dividend withholding tax to 5% for French companies holding more than 10% stake in an Indian entity, but raise the tax to 15% for shareholders holding less than 10% stake.
Resetting the MFN item
Some speculate that the proposed changes are aimed at addressing issues around the most favored nation (MFN) clause in the agreements. Ashish Karundia of Ashish Karundia said: “The Supreme Court of Nestle SA explained that the MFN clause is not automatically applicable unless beneficial ownership is specifically declared. The decision effectively restricts the ability of certain jurisdictions, including France, to claim a lower rate of dividend withholding tax or tax exemption on technical service fees in the absence of a ‘making available’ clause. So the proposed changes, including lower tax on dividends for higher stakeholders, appear to be a calibrated response.” & Co.
“From a structuring perspective, this may cause some FPIs to reassess their exposure to jurisdiction in France. Investors may examine deals with the Netherlands and Belgium, which continue to provide capital gains protection for assets below 10%. However, any restructuring must meet sound business justifications and content requirements to legitimately access deal benefits, especially after the Supreme Court decision on Tiger Global and anti-fraud standards,” Karundia said.
