P-note investors return to Mauritius as FPIs

P-note investors return to Mauritius as FPIs

Even as participatory notes (P-notes) become unattractive for taking positions, many investors are now looking to enter India using the foreign portfolio investment (FPI) route either through Mauritius or directly. 

P-notes are overseas derivative instruments with Indian stocks as their underlying assets. Industry trackers say some P-note holders are looking to directly invest in India without setting up an investment arm in a buffer country .However, some of the other investors could route their investments through Mauritius. 

The persons cited earlier said the newly registered FPIs will fall under category-III definition of the government and could start attracting higher taxes, going ahead. 

Many P-note holders invest in In dian futures and options (F&O) on which they did not pay any tax until recently. Also the instrument provided anonymity to these investors. However, the market regulator recently took two steps that forced investors out of P-notes.First is the insistence that KYC (know your customer) norms be followed strictly. Markets regulator Sebi also banned P-notes on derivatives last month. 

“Several P-note holders had to square off their positions in India due to the recent change in regulations, which has made it extremely hard to invest in the F&O segment unless that is done for hedging position on the same equity , which is not common. Now, some of these investors are looking to set up FPIs and invest in India directly from their country of origin, but that could attract up to 30% tax in India on the derivative returns,“ said Rajesh H Gandhi, partner, Deloitte Haskins & Sells.

Many FPIs are looking to come through Mauritius as the tax rate could be about 15%. However, there could be some risks if proper guidelines are not followed, say experts. FPIs may face scrutiny from Indian tax authorities over General Anti-Avoidance Rule (GAAR), Place of Effective Management (POEM) and they will have to display, without doubt, that the destination is not merely used for tax arbitrage. 

“Mauritius continues to be a preferred jurisdiction, especially for making investments in non-equity securities. The FPIs, however, would need to be compliant with GAAR, POEM and Principal Purpose Test guidelines in order to avail the treaty benefits,“ said Punit Shah, partner, Dhruva Advisors. Many investment banks have already commenced comparative analysis as to which destination could be better for them to enter India. Many of the category-III FPIs are flocking back to Mauritius as the destination provides cheaper operational cost. 

Recently, India also signed MLI (multi-lateral instruments) -a common tax agreement which could lead to uniform tax regulations for all investors, irrespective of which destination they come from. India is one of the 80odd countries that signed the MLI.It is expected that in the next two years, India will start adopting MLI, which could lead to uniformity of taxation for investors.

Many investment banks and prime brokers had started marketing P-note products aggressively in March this year. Until March 31, many FPIs invested in India through investment vehicles registered in tax havens such as Mauritius, Singapore and Cyprus. The government amended treaties with these countries and now tax will be levied on short-term capital gains on all investments made through these vehicles, beginning April 1. This had pushed several investors to explore P-note options.However, However, Sebi's tightening of norms has led to many investors again setting up FPIs. 

While the bigger investors, like hedge funds and pension funds, may not face difficulties, as they are exempted from several regulations like indirect transfer of shares, category-III FPIs could face more scrutiny from Indian tax authorities as they are not exempted from such regulations.

The Economic Times, New Delhi, 19th August 2017