India-France Tax Treaty May Hit P-Note Flows

A possible rewrite of the tax treaty between India and France could change how some foreign investors bet on Indian stocks. At the centre of the debate are participatory notes, better known as P-notes, a popular route used by hedge funds and global investors to gain exposure to Indian equities without registering directly in India.

While the government has not yet released the final text of the revised treaty, market participants say India may soon get the right to tax all equity sales by French investors. If that happens, it could alter the cost and appeal of investing through Paris.

Why Are P-Notes Suddenly Back In Focus?

P-notes are financial instruments issued by foreign portfolio investors registered with the Securities and Exchange Board of India. They allow overseas investors to take positions in Indian shares without opening accounts or dealing with heavy paperwork in India. For many hedge funds, the ease and anonymity made them attractive.

Their popularity has changed over time. Two decades ago, P-notes made up over 40% of foreign portfolio investments into India. That share has now dropped to below 2%, partly because of tighter disclosure rules. Even so, they remain useful for certain global investors.

After 2017, when treaty changes reduced tax advantages for investors routing money through Mauritius, Paris became an important hub for P-note issuance. French banks stepped in because the India-France treaty offered a key benefit. An investor from France holding less than 10% in an Indian company did not have to pay capital gains tax on the sale of shares. Since foreign portfolio investors cannot hold more than 10% in a company, this created a clear edge.

What Could Change Under The India-France Treaty?

According to people familiar with the discussions, India may now seek to tax capital gains on all equity sales by French investors. If the 10% threshold benefit is removed, the French route would lose its special appeal.

Removing the threshold would put France on par with countries such as Singapore, Mauritius, and Ireland. In that case, French broker-dealers issuing P-notes would be liable to pay capital gains tax in India. That added cost could reduce the attractiveness of selling P-notes from Paris.

Taxes on securities returns are built into P-note pricing. If capital gains exemption goes away and dividend taxes rise, the higher cost will likely be passed on to investors. This could make P-notes issued from France more expensive, especially since many investors may not be able to claim full tax credits back home.

The revised treaty is also expected to tweak dividend taxation. French companies holding more than 10% in an Indian firm may see dividend withholding tax reduced to 5%. However, shareholders with less than a 10% stake could face a 15% rate.

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Will Investors Shift To Other Countries?

The proposed amendments are also seen in the context of recent court rulings on treaty interpretation and anti-abuse standards. Tax advisers say that treaty benefits can no longer be assumed without clear notification and substance.

In the immediate term, there is unlikely to be an overnight migration of P-note desks from Paris to Amsterdam or Brussels. Setting up in another country involves regulatory approvals, staffing, compliance checks, and commercial justification. These decisions take time and planning.

That said, some funds may pause fresh allocations until there is clarity. Others may reassess whether alternative jurisdictions such as the Netherlands or Belgium offer a better fit under the evolving rules.

For India, the change could mean stronger tax collection rights. For investors, it becomes a straightforward question of cost versus convenience. Once the final text of the treaty is released, the direction of flows will depend less on speculation and more on numbers.

Sources

Economic Times

Moneycontrol