P-Notes under pressure: Double taxation avoidance pact with France hits offshore thematic bets

P-Notes under pressure:

The India-France Double Taxation Avoidance Agreement (DTAA) amendment, signed on February 23, 2026, during the French President's visit to India, allocates full source-based taxing rights on capital gains from share sales to India.

This means India now has the right to tax any profit made from the sale of shares in an Indian company by a French resident. Earlier, a French resident holding less than 10 percent of an Indian company was required to pay caital gains tax only in France. 

Market analysts have described the move as a potential "threat" or "hit" to P-Note (Participatory Note) trade and inflows through France.

P-Notes are financial instruments used by foreign investors to invest in Indian stock markets without having to register directly with the Securities and Exchange Board of India (SEBI).

Some market experts assess the overall disruption as limited, given the small scale and P-Notes' reduced footprint. Recent Sebi trends and expert estimates show that P-Notes form around 1.5-2 percent of total FPI (foreign porfolio invstment) assets under custody or AUC.

The move eliminates the prior exemption for French residents holding less than 10 percent in Indian equities and removes the Most Favoured Nation (MFN) clause, ending France's post-2017 appeal as a tax-efficient hub for P-Notes/Offshore Derivative Instruments or ODIs, and aligning the treaty with changes made to Mauritius and Singapore DTAs.

France-linked equity holdings stood at roughly $21 billion as of January 2026 (about 2 percent of total FPI exposure, as per depository data cited in Reuters and Financial Express reports), with P-Notes/ODIs forming a portion via issuances by French entities.

Liquidity and transparency implications

Short-term friction may emerge in equity liquidity as investors restructure, though P-Notes' small share limits systemic effects.

Sunil Badala, National Head of Tax at KPMG in India, viewed it as indirectly aiding SEBI's goals. "By reducing the attractiveness of opaque P Note structures routed via France, the change will likely accelerate the move towards more direct FPI investments and improve data quality and regulatory oversight," he said.

"There may be short-term friction in equity liquidity as investors restructure. However, based on the data available, as such, P Notes, today represent a very small fraction of total market participation," he said.

Tanvi Kanchan, Associate Director at Anand Rathi Wealth Limited, flagged targeted risks in "higher-beta, less-liquid corners of the market, not blue-chips." He specifically cited mid-cap NBFCs and private banks, specialty chemicals and pharma names re-rated on the China+1 thesis between 2021–23, mid-cap EPC, infrastructure, and realty plays built on the domestic capex cycle, and small-cap tech names too niche for standard index mandates.

Potential impact on inflows

The amendment could reduce the attractiveness of P Notes routed from France as capital gains tax (typically 12.5 percent long-term plus surcharge/cess) will be imposed on exits, potentially leading to gradual unwinds, slower fresh inflows, or shifts to direct FPI registration.

Badala noted that there is no public data on country-wise breakdown on P-Notes vs. direct equity... in the $21 billion, "notional value of ODI on equity as as percentage of overall FPI Asset under custody (AUC), it is in the range of 1.5 to 2 percent."

On revenue potential, he said the protocol "clearly expands India’s taxing rights, which should incrementally strengthen the capital gains tax base," with FY27-28 collections depending on "quantum of equity exit, upside in the market, holding period and applicable tax rate, grandfathering of existing investments if at all introduced."

Rajesh H Gandhi, Partner at Deloitte India, provided a modelling example: "Even a modest turnover of the $21 billion base could generate tens to hundreds of millions in tax revenue," such as around $62.5 million from $5 billion liquidated at 10 percent average gain under the 12.5 percent long-term rate (before surcharge/cess).

He emphasised containment, noting the impact is "limited to very few" participants, as France likely represents "one or two percent" of the market, and "compared to Tiger Global, this is a much smaller decision. So, the impact will be limited to very few because today [P-Notes are] only about three four percent and probably it could be one or two percent [from France]."

Gandhi also highlighted potential shifts. "Some of them already have a FPI licence. So think from the other perspective. Since the P-Note route is not giving me tax benefit, why should I incur the additional cost?"

Another law expert of capital markets, while speaking under the condition of anonymity, described the change as creating "a level-playing field between prime brokers sitting in Singapore, Hong Kong and France." He added, "I do not anticipate any significant change in the market because the market is also mature," noting P-Notes/ODIs are now used for "strategic business requirements" post-2014/2019 FPI liberalisations and December 2024 reforms requiring dedicated ODI licences and one-to-one equity hedging.

'Short-term exits likely'

Market experts are also wary of possible short-term exits. "If there are any grandfathering provisions or long-stop dates, maybe you could see some bit of exits but they will be very low," he said.

There's no clarity about the grandfathering or transition relief for existing investments (unlike Mauritius' phased 50 percent tax period), though the full protocol text has not been released publicly.

Grandfathering means that a new law will only apply to future cases, while existing situations continue to be governed by the old rules.

Badala highlighted uncertainty, saying, "As the text of the amending protocol has not yet been released, one will need to wait to determine whether any grandfathering or transition provisions have been included. In case the Protocol is entered into force before December 2026, it is likely that the amendments will apply in India from April 1, 2027." The protocol awaits ratification and exchange of notifications in both countries.

'Rerouting to Netherlands, Belgium likely'

On potential rerouting, Badala said that the Netherlands and Belgium continue to offer capital gains exemptions for holdings below 10 percent, similar to pre-amendment France, while the revised treaty aligns France with Ireland/UAE (no exemption).

He cautioned that short-term volatility from unwinds could occur, but "FPI flows are expected to stabilise in the medium to long-term horizon, given India’s strong macroeconomic fundamentals, robust corporate earnings outlook, and continued attractiveness as a growth market investment destination."

In contrast to Badala, Gandhi noted rerouting challenges, unlikely to Netherlands/Belgium due to anti-avoidance rules (GAAR/PPT, Supreme Court Tiger Global ruling), and UAE/Ireland lack CGT exemptions.

"P-Notes let offshore investors build positions without the cost and delay of direct FPI registration. When that conduit narrows, the incremental buyer disappears. No forced selling, but thinner demand support means any earnings miss or DII rotation hits harder," she said.

"Wherever French FPI entities hold hedge positions against their P-Note books, an unwind means actual selling, not just absent buying." She noted P-Notes' decline from 44.4 percent in FY2007 to ~2 percent now accelerates: "The treaty with France accelerates a structural decline already well underway."

The regulatory expert confirmed no derivatives impact. "Iit's not going to have an impact on the derivative market at all because anyways ODIs can't have derivatives underlying."

Experts see this as smaller than the 2017 Mauritius DTAA amendment (which had transition relief and larger P-Note scale). Kanchan called it "considerably smaller. P-Notes themselves are a fraction of what they were." Gandhi agreed.  "It is much smaller than Tiger Global. No other underlying domino effect is expected on the capital market."