India–France Tax Treaty Tweaks May Deal Fresh Blow to P-Notes Route

Proposed changes to the India–France tax treaty, said to be aimed at addressing concerns around the most favoured nation (MFN) clause, could deal another blow to the trade in participatory notes (P-notes) — a route long used by hedge funds and offshore investors to take exposure to Indian equities, The Economic Times said.

Participatory notes are offshore derivative instruments (ODIs) issued by Securities and Exchange Board of India (SEBI)-registered foreign portfolio investors (FPIs).

These instruments derive their value from underlying Indian equities and allow overseas investors to gain market exposure without directly registering with Indian regulators. Following amendments to India’s tax treaties with Mauritius and Singapore in 2017, Paris emerged as a preferred destination for P-note investments.

Under revised treaties with Mauritius and Singapore, capital gains arising from the sale of Indian equities on or after April 1, 2017 became taxable in India. In contrast, FPIs based in France — provided they held less than a 10% stake in an Indian company — were not liable to pay capital gains tax on stock sales.

Since FPI regulations cap ownership in a single company at 10%, French entities effectively enjoyed a tax-efficient route. This advantage extended to both direct equity investments and participatory note structures linked to French FPIs.

However, regulators have long been wary of P-notes. While investors earn returns through dividends and capital gains, Indian authorities have raised concerns that hedge funds operating through anonymous derivative structures could exacerbate volatility in domestic markets.

The opaque nature of P-note transactions makes it difficult for regulators to trace the final beneficial owners, raising concerns about unaccounted funds entering the country.

Over the years, SEBI has progressively tightened oversight. In 2025, the market regulator mandated that FPIs issuing offshore derivative instruments must obtain a separate registration tagged with an “-ODI” suffix under the same Permanent Account Number (PAN).

It also banned FPIs from hedging exposures created through ODIs, a move industry participants said would significantly restrict the scope for building synthetic positions in Indian markets.

Data reflect the steady decline of the instrument. According to a report by The Financial Express, at its peak in FY07, investments routed through P-notes stood at Rs 2.40 lakh crore, nearly comparable to the mutual fund industry’s assets under management of Rs 3.3 lakh crore at the time. Since then, their prominence has fallen sharply, with the outstanding value now estimated at around Rs 1.36 lakh crore.

With the proposed India–France treaty revisions potentially removing the remaining tax arbitrage under the MFN framework, market participants expect the P-note route to make investor sentiments jittery, marking another step in India’s broader push towards greater transparency in foreign portfolio flows.