Mauritius & P-notes: Any proposed change in rules may spook Dalal Street

Just as every new government fiddles around with high school history text books, it also dabbles in Mauritius and P-notes. Both actions have a sharp, short-lived impact, leaving behind a trail of conspiracy theories.

Mauritius and P-notes are ghosts that New Delhi and regulators could never quite exercise. They unfailingly show up every few years to spook financial markets — spawning sinister plots around bear operators having the last laugh. In the past, such stories were sparked by bureaucrats’ bad drafting and ministers’ veiled hints. This time around the triggers are different — at a time when India is renegotiating the treaty with the tax haven, a former minister of Mauritius hinted that the treaty has lost its meaning; the second trigger – and this rattled the market — are the simplistic suggestions of a panel to curb black money. Given the government’s obsession about black money and Swiss accounts, Dalal Street punters feared trading in P-notes could be banned.

The man in Mauritius said his country would lose the right to tax capital gains (CG). If true, it means the end of Mauritius as we know it. How? The treaty says that India cannot tax the CG of investors from Mauritius; only Mauritius can. Since there is no CG tax in Mauritius, these investors pay no CG tax in either country. That’s the beauty of Mauritius. So, if Mauritius gives up the right to tax, it means India could end up taxing foreign investors on their short-term CG in the stock market.

Can this happen? Only if the government believes it’s a fabulous opportunity to raise revenue, and India is too irresistible a story for foreign investors to ignore. No government has taken such a bet.

It’s unlikely that the current one – criticised for its handling of the “minimum alternate tax” on foreign investors — would. The demise of Mauritius as a tax haven would also mark the end of Singapore — another country that has signed a similar treaty with India — as a destination for fund managers investing in India. The rules are clear —if investors from Mauritius are taxed in India, so will be the ones coming from Singapore.

Since few believe Team Jaitley would precipitate this, the Mauritius question fizzled out (though it could resurface). The rules, however, may change: investors in Mauritius may be asked to spend some money every year (as they do in Singapore) to claim tax benefit in India.

It’s an exercise to demonstrate that they are genuine investors – with managers, offices and secretaries — and not just faceless, brass plate entities. It’s not certain how this would benefit India, but it could create a property boom in Mauritius.

For the market any curb on P-notes is a clear and present danger. P-notes are offshore instruments to trade on Indian stocks and are held by investors who want to bet on India without the hassles of setting up vehicle in Mauritius. The panel, rather naively, voiced concern about the concentration of P-note investors in Cayman Islands which of course evokes images of white sand and drug dealers. But this is only natural as Cayman is the best regime for hedge funds, which are large holders of P-notes. The notes are offshore financial instruments, issued abroad by foreign institutions, traded in offshore destinations by investors registered in distant locations. What exactly can Sebi or the government do to restrict their trades?

Some rules are already in place. Individuals and corporates can no longer buy P-notes, only regulated investors – like funds, asset managers and brokers whose names are disclosed to Sebi every month – are allowed to trade. Notes change hands with the consent of P-note issuers and if Sebi smells a rat, it can always approach the fund or other regulators for more information.

Mr Jaitley and finance ministry officers have ‘clarified’ that the government has not taken a decision. They should not let Mauritius and P-notes snowball into controversies like the MAT or GAAR.