Indian equity market ended in the red on Monday on concerns the government could tax participatory notes (P-Notes), which are issued by foreign portfolio investors registered with Indian market regulators to overseas investors.
An introduction of the General Anti-Avoidance Rule (GAAR) next month could trigger the move to tax these notes. This would result in foreign investors selling holdings in order to avoid the potential tax. Otherwise, they may also shift base to locations that could provide a way to avoid payments, before the end of the end of the fiscal year.
According to provisional National Stock Exchange data, FIIs sold Rs 1.35 billion on Monday.
Finance Minister Pranab Mukherjee has said that GAAR is under consideration in the parliament. "I'm not sure why markets are down due to GAAR," he questioned.
Mukesh Butani, Chairman, BMR Advisors told NDTV Profit that a group of FIIs have worked together and taken this conservative view that the government will stop issuing Participatory-notes as a result of combination of amendments in the Income Tax Law.
“Some foreign investors have also said that they should re-look at issuing the participatory-Notes. As far as the Department of Revenue is concerned, an amendment has been moved and that amendment is subject to passage by both the houses of Parliament. On many occasions, the Department of Revenue in the last one week has clarified that the circular of Mauritius treaty is available. So it is a conservative view,” he explained.
“If you look at the direct tax code (DTC) provision, the provision also suggests that it’s only if there are indirect transfers and 50 per cent assets are located in India, then these indirect transfers can be brought to tax in India. Now how can the 1961 Act be more stringent than the DTC provision? So that is the reason I question the wisdom of this interpretation that the amendment that the government has brought in this year's budget to retrospectively tax a Vodafone kind of transaction, can also tax a Participatory note. I think this is what has caused the nervousness,” he added.
"Ambiguity pertaining to P-note taxation under GAAR is leading FIIs to wind up their positions," said Prakash Diwan, head of institutional clients at Asit Mehta Investment Intermediates.
"We expect more profits to be home by FIIs at least until 31st March," Diwan added.
(With inputs from Reuters)