Many foreign institutional investors (FIIs) invest in Indian stock markets through participatory notes (P-notes). These P-notes are issued by foreign portfolio investors registered with the SEBI, and do not pay tax in India. Investments through these instruments are estimated at a staggering Rs 1.8 lakh crores. If these notes are going to be taxed due to GAAR provisions, many foreign investors will have to re-visit their strategies.
A lot of these investments come through Mauritius which has been a tax haven, thanks to India signing a Double Tax Avoidance Treaty with India.
Taxing P-notes may spook markets
Now if tax authorities decide to go after Participatory Notes and bring them under the purview of tax, there are likely to be repercussions.
Firstly, large scale foreign fund flows will be stalled and those investing through the Mauritius route might re-evaluate their strategy. It may not be prudent for the Government to get after P-Notes, as it could drive foreign investors away. At a time when the rupee is fragile the government cannot even think of doing it, as it could lead to a sharp depreciation in the rupee. It will also create havoc with the current account deficit, which has spiralled above 3% of GDP.
It must be admitted at this point in time, the implications and the GAAR provisions still remain ambiguous. However, on Monday it spooked the markets with the Sensex losing a staggering 309 points, as markets were petrified that if taxed, India could see an exodus from foreign investors.
The government as usual has not come out and clarified on the GAAR provisions. It is better to do so quickly, before foreign investors re-evaluate their India strategy.