Non-bank FPIs at Gift City to gain from tax relaxation on p-notes

Govt provided further sops ion the Budget for FY26 for investors using Gift City

Leading foreign financial institutions such as Goldman Sachs, Morgan Stanley, and UBS are set to benefit from relaxations provided in Budget 25 for participatory notes (p-notes) issued from the International Financial Services Centre (IFSC), Gift City.

Until now, tax exemptions were available only to only p-notes issued by institutions registered as International Banking Units (IBUs) in Gift City. Now the exemption applies to p-notes issued by all institutions that are registered as a Foreign Portfolio Investor (FPI) with SEBI, and have a base in Gift City.

The p-note income — arising from stock market transactions —  distributed by IBUs to non-residents was exempt from taxes thus far. Now the government has extended this provision to even p-note income distributed by non-IBUs.

Currently, there are 23 banks registered as IBUs, including Deutsche Bank, Standard Chartered, and JP Morgan Chase, per IFSC data.

Financial institutions like Goldman Sachs, Morgan Stanley, and UBS are not registered as IBUs. The changes would mean that FPIs will enjoy the same privileges as IBUs in terms of p-notes. Besides issuance of p-notes, IBUs are also in the business of lending from IFSC.

The development assumes significance as all the three non-IBUs are leading issuers of p-notes in the Indian on-shore market in Mumbai.

P-notes are used by some off-shore funds who want to invest in India without having to register as an FPI here. In such cases, the issuer of such notes is always a registered FPI who acts as an intermediary. Based on the order placed by the p-note buyer, the FPI buys the securities.

The p-note is a contract that promises to pay the investor returns based on the performance of the underlying Indian securities.  The investor essentially gets the economic benefit of owning the securities without actually holding them.

“This amendment will encourage offshore entities to shift their ODI (offshore derivative instrument)  business from jurisdictions like Mauritius and Singapore to the IFSC. Now, non-bank FPIs, such as broker-dealers and Alternative Investment Funds (AIFs) may also be able to commence such businesses in the IFSC,”  said Suresh Swamy, Partner, Price Waterhouse & Co LLP.

Emails sent to Morgan Stanley and UBS remained unanswered at the time of publishing this story. Goldman Sachs declined to comment on the matter.

Budget 24 tweaks were not enough

In Budget 24, the government gave legal sanctity to p-notes issued from IFSC and several rules, including SEBI’s FPI rules, were amended to allow the same. Under these rules non-IBUs were also permitted. However, the regime didn’t take off due to tax complications. According to the 2024 budget announcements, the p-note income distributed to non-residents only by IBUs was exempt from capital gains tax. Now the government has extended this benefit to non-IBUs as well.

“One interesting proposal relates to the income tax exemption to non-resident investors in any unit in the IFSC (not only banks) from transfer of non-deliverable forwards, off-shore derivative instruments, or over-the-counter derivatives, including any distribution of income arising from these instruments. This should incentivise funds here that issue such instruments from other offshore locations to move their base to the IFSC,” said Keyur Shah, Partner and Tax leader – Financial Services, EY India.

Until now, the income distributed by non-IBUs was not tax-exempt. So,  if a p-note was issued by an FPI to, say, a Singapore entity, then the Singapore entity receiving the income is subject to tax in India. Tax experts say it was difficult for the off-shore entities to avail of benefits under Double Tax Avoidance Agreements (DTAAs) for such income, and potentially they could be subject to tax in both India and Singapore (in this case).

One condition under DTAAs is that the person / entity claiming the benefits must be the beneficial owner of the investments. Further, there are tests to ascertain if a person is a beneficial owner or not. Off-shore funds often have a multiple -layer structure, thus, even if the p-note subscriber is registered in Singapore or Mauritius, the actual end-beneficiary may be in the US or Europe. Hence, Indian tax authorities may reject the treaty benefits.

Tax experts added that most non-IBUs perceived this as a regulatory risk and did not issue p-notes from Gift City, although the rules permitted them. But now there is more regulatory clarity on taxation of such assets and global institutions should be more inclined to get into the business.