India–France treaty revision raise concerns about P-Note trade

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.

• India to revise tax treaty with France, affecting P-note investors
• French FPIs may face capital gains tax on Indian equity sales
• P-note investments may become pricier, impacting foreign inflows.

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The Centre is likely to make changes to the India-France treaty that will tilt the balance in favour of India in terms of tax revenue but may lead to potential short-term reduction in foreign inflows.

According to a report in the Economic Times, although the government is yet to release the revised treaty,  once passed, India will have the right to tax all equity sales by French investors, who invest in Indian stocks through participatory notes (P-notes).

Participatory Notes (P-Notes) are offshore financial instruments issued by foreign portfolio investors (FPIs) registered with the Securities and Exchange Board of India (SEBI) to overseas investors, who want to invest in Indian securities without registering directly with SEBI. It is a hit with hedge funds and international investors as it entails minimum paperwork and ensures anonymity.

After 2017, when Mauritius lost some of its charm as a tax haven, P-notes began to be sold by leading French banks. This could now change if revisions to the treaty remove France's serious tax advantage compared to other jurisdictions.

According to the Economic Times, investors from Mauritius and Singapore pay tax on profits from sale of Indian equities bought on or after April 1, 2017. However, an FPI from France holding less than 10% in a company pays no tax on capital gains from stock sale.

Rajesh Gandhi, partner of Deloitte India, said if the 10% beneficial threshold under India-France treaty is removed, it will place the French treaty on par with India's treaties with Singapore, Mauritius and Ireland, making the French broker dealer or P-note issuer liable to pay capital gains tax in India. The amendments could therefore force French FPIs to stop P-note sales or change strategy.

Parul Jain, who heads the international tax practice at the law firm Nishith Desai Associates, said 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.

Ashish Karundia of Ashish Karundia & Co explained that the Indian government's move 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.