Proposed tweaks to India–France tax treaty may further reduce attractiveness of P-notes issued from that country

P-notes are financial instruments used by foreign investors to invest in Indian equity markets without registering directly with the market regulator.

A set of proposed changes to the India–France Double Taxation Avoidance Agreement (DTAA) could reduce the attractiveness of participatory notes (P-notes) issued by France-based global banks, people familiar with the developments said.

France currently remains the only major jurisdiction where P-note subscribers can avail of zero capital gains tax without triggering anti-avoidance rules. According to sources who spoke to Moneycontrol, India and France are engaged in negotiations to revamp the treaty, a move that could lead to a higher tax incidence in certain cases.

One of the key proposed changes relates to dividend taxation. Under the revised framework being discussed, the dividend tax applicable to French investments holding less than 10% equity in an Indian company could increase to 15 percent from the current 10 percent. P-note investors always keep their stake less than 10% in a company and therefore the proposal will have impact across the French p-notes. Experts said this would significantly raise the tax cost of French-issued P-notes, reducing the arbitrage advantage compared with jurisdictions such as Mauritius or Singapore. However, France may continue to remain a preferred destination for P-notes due to the capital gains tax exemption that still exists.

Tax experts said long-term investments of more than two years routed through French P-notes could face a disadvantage, as dividends typically form a larger component of returns in such structures. “France is an evolved jurisdiction that provides significant protection from General Anti-Avoidance Rule (GAAR) concerns. Some banks may continue issuing P-notes from France despite the higher tax outgo due to tax certainty,” said a person cited earlier.

An email sent to the Finance Ministry remained unanswered.

France has emerged as the centre of India’s P-note industry, with both French and American banks issuing P-notes from the country due to prevailing tax exemptions. French banks such as BNP Paribas, Société Générale and Natixis, along with global banks including Bank of America, offer P-notes from France. Overall, France is the ninth-largest source of foreign portfolio investment into India, with French funds owning equities worth over Rs 2 lakh crore.

P-notes have continued to play a role in attracting new off-shore funds. The importance of such investments  for Indian equity markets has come back into focus amid sustained foreign portfolio investor (FPI) outflows in recent months. Although FPIs net sold shares worth Rs 1.6 lakh crore in 2025, assets under P-notes have grown 18% from Rs 1.25 lakh crore In January to Rs 1.47 lakh crore in October, Sebi data showed.

Market participants said any disruption to P-note structures—particularly from a key jurisdiction such as France—could impact incremental foreign flows into India at a time when overseas participation has already turned selective.

However, the role of P-notes in India’s equity markets has structurally diminished over time. The share of participatory notes in India has fallen sharply from over 50 percent of total FPI assets in 2007 to around 1-2 per cent currently. This decline has been driven largely by stricter regulations imposed by the Securities and Exchange Board of India (Sebi) to curb misuse. However, their absolute value has seen intermittent spikes in recent periods, driven by demand for mid-cap stocks and phases of strong FPI inflows.

Until 2017, Mauritius was the preferred jurisdiction for P-note issuances into India. However, India amended its tax treaty with Mauritius in 2017, removing most exemptions, including those related to capital gains tax.

Separately, India also implemented GAAR in 2017, which curtailed the use of tax havens by foreign investors to route investments into India. Under GAAR, investors were required to demonstrate “commercial substance” in the jurisdictions through which investments were routed.

Commercial substance entails having an office, business operations, and employees in the jurisdiction. This became a challenge for many Mauritius-based P-note investors, who often struggled to justify their investment routes to tax authorities.

While certain types of P-notes issued from Mauritius remain eligible for tax exemptions, demonstrating substance has become difficult, prompting many P-note desks to shift away from the island nation to France.

“Other developed countries where institutions can demonstrate substance do not offer tax exemptions with India. France stands out as a commercial hub where substance can be easily demonstrated while still offering tax exemptions,” said another person cited above.

According to the proposals under discussion, French entities holding more than a 10 percent stake in an Indian company would be subject to a concessional dividend tax rate of 5 percent. However, entities holding less than a 10 percent stake would face a 15 percent dividend tax, compared with the current 10 percent rate.

This change would directly impact P-notes issued from France, as such structures are permitted to hold only up to a 10 percent stake in Indian companies.

“Reports over possible changes to the India–France DTAA have sparked concerns among France-based FPIs and P-note issuers. If the stake of the French company is less than 10 percent, it will be subject to a 15 percent dividend tax instead of the current 10 percent. Since all FPIs and P-note holders own stakes below 10 percent in listed companies, the proposal has a direct impact on them,” said Suresh Swamy, partner at Price Waterhouse & Co LLP.

He added that the proposed changes could also make GIFT City more attractive, as French entities could route investments through the IFSC for a lower dividend tax rate of 10 percent.

P-notes are financial instruments used by foreign investors to invest in Indian equity markets without registering directly with the market regulator. They are primarily used because they offer a faster and simpler route for large international funds to bypass extensive regulatory requirements for direct registration. Global custodian banks with foreign portfolio investor (FPI) licences issue these instruments to their clients.

Until 2014–15, P-notes also offered anonymity, as custodian banks purchased shares on behalf of subscribers. However, Sebi later tightened regulations, making disclosure of beneficial ownership mandatory.

“The proposed revision in dividend rates clearly differentiates between strategic ownership and portfolio capital. While French shareholders with more than a 10 percent stake benefit from a lower 5 percent dividend withholding, minority investors—where most FPIs and participatory note structures sit—will see the tax cost rise to 15 percent, reducing the post-tax internal rate of return for portfolio inflows,” said Binoy Parikh, partner at Katalyst Advisors.