New Delhi: Nearly five months after the Union Budget paved way for P-notes, or participatory notes, in India's GIFT City, some leading global banks are considering shifting there as it provides both tax sops and regulatory clarity, Mint reported, citing sources.

Some of the banks – who have already started pitching P-notes to their clients – are expected to launch full-scale issuances by the end of the year, the business daily reported.

The budget this year exempted taxes on income generated from trades in offshore derivative instruments, also known as P-notes, by a foreign investor in the Gujarat-based International Financial Services Centre (IFSC) in GIFT City.

Therefore, GIFT City is being seen as an attractive destination for foreign investors to indirectly invest in the Indian securities markets, without having to disclose their identity. The opaque structure of these instruments has made regulators uncomfortable several times.

Experts told the HinduBusinessLine that P-notes could "act like steroids" for India which is "parched for foreign money".

Reports say this money could have been used to launder money by wealthy Indians, like the promoters of a company, to bring back unaccounted funds, or black money, into the Indian markets and manipulate stock prices.

This is what Hindenburg Research has alleged in its report against the Adani Group.

Also read: Because of Repealed Provisions, SEBI Hit ‘Opaque Structure’ Wall While Investigating Adani: SC Panel

What are P-notes?

P-notes are financial instruments required by investors or hedge funds to invest in Indian securities without having to register with the Securities and Exchange Board of India (SEBI).

Simply put, one doesn't need to register with the capital markets regulator to invest in the offshore derivative instrument. That's why, the investor remains anonymous. And, an investor can further use intermediaries to obscure its position.

P-notes were partially banned in 2007 for a while.

US short seller Hindenburg Research's January 24 report on Adani Group raised questions over the exploitation of loopholes in the Indian securities market through P-notes. Due to the opaque structure, it's not known how some funds were invested in the conglomerate's listed entities through a web of offshore entities.

Several bankers familiar with trading in Indian securities had told Reuters that P-notes could have been a profitable way for Hindenburg Research to place bets on the Adani Group.

“In the last decade, the bulk of the P-note market has moved offshore amid regulatory crackdown in India. But such instruments are vital for a country to attract a wider pool of foreign investors," a stock exchange official told Mint. “A lot of discussions are now happening between the banks and regulators regarding P-note issuances," the official said.

According to SEBI rules, foreign portfolio investors (FPIs) are required to share the details of P-note holders with SEBI upon request. Any FPI, or its sub-accounts, including those issuing P-notes, cannot hold more than 10% of the total issued capital of an Indian company.

However, a P-note investor may cut deals with several funds and hold below the 10% threshold in each fund and remain unnoticed.

Also read: The ‘Gift’ Economy of Higher Education That Keeps on Giving

Norms for P-notes

FPIs typically pool funds in tax havens, and trade in emerging markets like India through vehicles in jurisdictions like Mauritius and Singapore which have tax treaties with India.

The tax sops for P-notes announced in the budget were said to be a more significant move than the Double Taxation Treaty Agreement (DTAA), which, as the name suggests, helps taxpayers avoid double taxation. India has a DTAA with more than 80 countries, including the UAE, Germany, Mauritius, Singapore, the UK, the US, Australia and Canada.

An individual who is a resident of one nation but earns income in another is eligible to availing of benefits under the DTAA.

But tax is a major risk for P-note subscribers as the tax department has in the past declined treaty benefits to beneficiaries, Mint reported.

The non-resident needs to meet several criteria set by the tax department to avail of tax benefits under DTAA.

However, in IFSC, every tax benefit has been codified into law. Hence, there is no need for treaty exemptions, market participants told the business daily.

“Investing from Gift-IFSC will provide more certainty with respect to taxation as entities will no longer be required to avail treaty benefits. All the benefits are coded in the domestic tax law itself," Suresh Swamy, a partner at Price Waterhouse & Co. Llp, told Mint.

Since a long time, concerns have been raised over the anonymous investors who are beyond the reach of Indian regulators or taxmen.

We could see from the Adani-Hindenburg saga how the FPI chain can be structured to mask the real owners. Moreover, while investigating the allegations by Hindenburg Research against Adani, SEBI hit a wall because provisions of requiring FPI to disclose “ultimate natural person” were done away with in 2018.

Being a a vocal supporter of the need to curb black money, the setting up of an onshore financial centre in itself appears like a paradoxical decision, which is worrying.

Investment in the Indian capital markets through P-notes hit a four-month high of Rs 95,911 crore in April. The P-notes investments stood at Rs 88,600 crore in March-end, PTI reported citing SEBI data. This included the value of P-note investments in Indian equity, debt, and hybrid securities.

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