Finance Bill looks at taxing P-Notes prospectively,clarification awaited

The government is unlikely to tax participatory notes and offshore derivative instruments retrospectively under the proposed amendment of Section 9 of the Income Tax Act and may issue a clarification regarding the same

Written by Shruti Srivastava | New Delhi | Published: March 28, 2012 1:09:00 am

The government is unlikely to tax participatory notes (P-Notes) and offshore derivative instruments (ODIs) retrospectively under the proposed amendment of Section 9 of the Income Tax Act and may issue a clarification regarding the same.

The proposed amendments in Section 9 could be far reaching as it would impact “indirect transfers”,which will include P-Notes as well.

P-Notes are derivative instruments through which foreign institutional investors (FIIs) not registered with market regulator Securities and Exchange Board of India (Sebi) invest in stock markets.

In the Finance Bill,2012,the government has proposed to amend the section in wake of the Supreme Court’s judgement in the Vodafone case wherein it was ruled that the Indian tax authorities have no jurisdiction to tax Vodafone-Hutch deal.

“Our intent is not to tax P-Notes. We will clarify the concerns of FII’s,and P-Notes. Since both P-Notes,and offshore derivative instruments are indirect transfers,they may come under the amended Section 9,” an official source told The Indian Express.

The official said that the ODIs and P-Notes would be taxed prospectively if they become taxable. The proposed amendments to Section 9 are retrospective from 1962.

So,if the short-term capital gains tax is paid on the direct transfer,indirect transfers will not be taxed to avoid double taxation.

However,if treaty benefit is claimed,the official said the proposed amendments in the Finance Bill would be applied to ensure that the claim is legitimate.

Further,the government proposes to introduce general anti-avoidance rules (GAAR),which will be invoked when entities try to seek tax benefit under the double tax avoidance treaty.

GAAR would be applied when an entity fails,what is called,main purpose test. The department will have to then prove either of the four other tests — abnormality test,misuse and abuse of provisions of law test,bonafide purpose test,and lack of commercial purpose substance test.

This will also help the country to track black money as well.

The entities investing in India will have to show their source of funds,ownership,control of funds along with value and location if they seek treaty benefit. This,experts fear,may lead to a dramatic decline in issuance of P-Notes. The most impacted will be FIIs and P-Notes from Mauritius.

According to Sebi figures,the total value of P-Notes on equity and debt including P-Notes on derivatives is estimated at around Rs 183,151 crore,which is 16.4 per cent of the total assets under custody of FIIs at Rs 11,15,648 crore as of February 2012.

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