Fears that the removal of tax benefits on investments coming from Mauritius will adversely impact Dalal Street seem to have been exaggerated. The benchmark BSE Sensex fell around 360 points, or 1.4% on opening but later recouped most of its losses amid mixed cues from Asian markets. In other words, the market movement, barring an initial knee-jerk reaction, is being guided by developments in the global market and not so much by the amended tax protocol with Mauritius, which accounts for nearly 20% of the foreign portfolio investors’ (FPI) assets in the country.


Experts believe the market has been able to take the development in stride thanks to the approach the government has taken. Firstly, India has decided to exercise the right to tax capital gains on investments from Mauritius from the start of the next financial year, giving participants nearly an 11-month breathing period. Also, the short-term capital gains tax rate will be 7.5%, half that levied on domestic investors for the first two years.


“The grandfathering date of April 17 and a 50% concessional rate up to April 2019 augers well and provides certainty to investors on the applicability of treaty as investors have been nervous on the future of the Mauritius treaty,” said Mukesh Butani, managing partner, BMR Legal.


As per data available provided by depositories, equity assets of Mauritius based investors currently stands at Rs 3.78 lakh crore, 20% of the overall FPI equity assets of Rs 18.9 lakh crore. The assets are essentially the value of their investments in listed companies at the end of March 2016. The grandfathering clause would mean there won’t be any tax implication on these existing investments and incremental flows coming from April 2017 would attract capital gains tax.


“Yes, it would push tax costs for investors but there is certainty and clarity. India in the medium to long term will continue to attract investments. A stable environment will auger well for the Indian rupee which would make the tax cost look insignificant,” said Butani.


Besides the taxation structure, stability in the local currency is an important aspect for attracting overseas investments. A sharp depreciation in the local currency can hurt the returns of overseas investors.

Impact on P-notes

An area the Street is worried about is what would happen to investments routed through offshore derivatives instruments (ODIs), or in other words participatory notes (P-notes). As on March 2016, equity assets under P-notes stood at Rs 2.23 lakh crore, nearly 12% of the total FPI assets.

Experts believe investments into India through the P-note route will take a major beating after the new Mauritius treaty and also if subsequently a similar agreement is made with the Singapore government. As per estimates, nearly 70% of the P-note issuance happen in Mauritius and Singapore.

A note by law firm J Sagar Associates says: “Issuers of promissory notes may be adversely affected by protocol as costs of taxation arising out of the changed position on taxation would have to be built into such arrangements. This would make such arrangements not only costly but also less lucrative for investors who seek synthetic exposure to Indian securities.”

P-notes are essentially used by overseas investors to invest in the Indian market without having to register with market regulator Securities and Exchange Board of India (Sebi). These instruments are issued by FPI registered with Sebi.

Legal experts believe there could be operational issues between the FPI, or the P-note issuer and the P-note holder due to the new tax changes. The instrument may not be tenable and might require extensive restructuring, believe experts.

This, however, may not necessarily make a huge dent on the markets for two key reasons. First of all, the significance of P-notes as a vehicle to take exposure in domestic stocks. Consider this: at its peak, P-notes accounted for nearly 40% of the total FPI holdings. This is down to less than 12% currently.


Secondly and more importantly, a lot of investors who earlier used to take the P-note route have now registered with Sebi, following easing of the KYC (know your client) norms. The market regulator in 2014 revamped the investment process for overseas investors by introducing the FPI Regulations, 2014. The new regulation was aimed at easing the entry for overseas investors by simplifying and streamlining the registration and the KYC process. The move has yielded good results. In 2015-16, the total FPI count had more than doubled to 3,992 from 1,444 at the end of 2014-15.