Instruments issued by registered foreign institutional investors (FII) to overseas investors, who wish to invest in the Indian stock markets without registering themselves with Securities and Exchange Board of India are called Participatory Notes or P-Notes.

1. 1
WHITE PAPER ON
PARTICIPATORY NOTES
A PRODUCT OF RICKY CHOPRA INTERNATIONAL COUNSELS

2. 2
PECULIARITY OF PARTICIPATORY NOTES
In the past decade, there has been a lot of hullabaloo over the Offshore Derivative
Instruments- “Participatory Notes”
To start with, we define Participatory Notes (hereinafter referred to as “P-Notes”) and why
they have always been a cause of concern for the Market Regulators.
CONCEPT
Participatory Notes commonly known as P-Notes or PNs or Off-Shore Derivative
Instruments (ODIs) are instruments issued by registered Foreign Institutional Investors
(FII) to overseas investors, who wish to invest in the Indian stock markets without registering
themselves with the market regulator, the Securities and Exchange Board of India - SEBI.
These instruments are not open for domestic investors.
A Foreign Institutional Investor (FII) is an investor or investment fund registered in a
country outside of the one in which it is investing. Institutional investors most notably include
hedge funds, insurance companies, pension funds and mutual funds. The term is used most
commonly in India and refers to outside companies investing in the financial markets of
India.
Foreign investors wanting to buy smaller quantities of Indian debt and stocks can use two
routes.
1. By registering with the market regulator SEBI as Foreign Portfolio Investors (FPIs)
and investing in to India.
2. Those who do not wish to register with SEBI can buy Indian assets by buying P-
Notes.
Foreigners willing to buy larger stake in Indian companies use the Foreign Direct
Investment (FDI) route.
Foreign Direct Investment
•FDI investors are long-
term investors
Foreign Portfolio
Investment
•FPIs are medium or short
term investors
Participatory Notes
•P-note buyers are ultra-
short term investors

3. 3
FLOW OF P-NOTES
P-Notes are contracts issued by FIIs to entities outside India. These contracts have either
equity, debt or derivatives as underlying. Many foreign investors preferred to use this route
for investing in to India as it is speedier and required lesser regulatory compliance. Others
use this channel to hide their identity from the Indian regulator.
Registered foreign portfolio investors such as JP Morgan, Goldman Sachs and UBS issue P-
Notes. The dividends from the stocks purchased are transferred to the end investor.
This is illustrated below:
As describe in the chart above, the foreign investor has issued a buy order for certain X shares
from Indian Stock Market. This buy order has been given to the FII abroad, which in turn
has relayed the instructions for execution of buy order to its office based in India. The India-
based FII executes the buy order and confirms the same to its parent office abroad and issues
Participatory Notes to the investor, with X shares as underlying assets. Subsequently any
dividends or capital gains collected from the underlying instruments flow back to the
investors.
Profits in P-Notes: - Whenever the price of the X Shares goes up, the investor will instruct
the FII to sell them. FII after deducting commission will return the principal and profit to the
investor and Investor will return the P-Note receipt to FII. Consequently, FII will sell the P-
note receipt to another foreign investor.
Foreign Investor
Foreign Institutional Investors
Abroad
Foreign Institutional Investors
(Branch in India)
X Shares
(Indian Stock Market)
Buys X
Shares
Buys X
Shares
Buys
Confirmation of
Shares Purchased
Issue Participatory
Notes Receipt to
Investor

4. 4
In complete process, details of the overseas investors remain anonymous to Indian market
and SEBI. Hence, the PN system is deliberately biased and seems to favor ghost investors.
GOVERNMENT & REGULATORS’ CONCERNS
P-Notes have been controversial instruments from the beginning and every time the
government wants to regulate them, market starts falling, preventing the government to take
the harsh steps. The government fears that P-notes are being used as instruments for money
laundering and terror financing. Even listed company promoters are believed to re-route their
investments in their own companies through the P-note route. This allows them to contravene
the stringent insider trading norms that regulate such proprietary investments.
CHRONICLE
Ever since the inception of P-Notes, they have always been in news for all the wrong reasons.
To counter their anonymity, SEBI introduced “Know-Your-Customer” (KYC) norm in 2003.
This norm requires FIIs to furnish details regarding the real investors as and when demanded
by SEBI. To comply with this norm, FIIs keep a record of the clients to whom P-Notes are
issued, but easy transferability creates multi layers which make it difficult to identify the end
beneficiary. However, the RBI for long has been opposing the idea of P-Notes’.
A Special Investigation Team (SIT) appointed by the Supreme Court, came out with a report
on black money and exposed the links between Indian stock market and international tax
havens.
SEBI has recently taken a series of actions to tighten regulation to prevent the misuse of this
channel. Greater scrutiny has now brought the total assets managed as P-Notes from 56 per
cent in 2007 to 10 per cent in 2016. Taking cues from the suggestions, SEBI has now made
it mandatory for the P-Notes holders to adhere to Indian Know Your Customer (KYC) or
Anti-Money Laundering (AML) norms. FPIs have also been directed to report details
about onward issuances of these contracts. A P-Note buyer is also now required to inform
the issuer before he transfers the contract to another entity.

5. 5
P-NOTES AND CAPITAL GAIN TAX EVASION
Capital Gains tax is a direct tax levied on profit from sale of shares/bonds/gold etc. It is
possible to evade capital gains tax via P-notes. Observe in the following table below:
INVESTMENT WITH P-NOTES INVESTMENT WITHOUT P-NOTES
Foreign Investor (Mr. A & Mr. B) can buy
Indian shares via FII via P-Notes, without
having PAN and DEMAT Account.
Foreign Investor (Mr. A & Mr. B) must
have PAN and DEMAT Account to buy
and sell shares.
Mr. A sells this P-note to Mr. B at profit.
Mr. B doesn’t need to pay CGT to Indian
Government, because of anonymous
identity the authority cannot trace them.
Even if P-Note is sold 10 times to 10
different people, the government cannot get
CGT.
The Government will get CGT only once,
when the said P-Note owner instructs the
FII to sell the Shares from its Indian
DEMAT Account.
If Mr. A sells his shares to Mr. B and
makes profit, then Mr. B will have to pay
Capital gain tax to India.
Because Income tax official can trace it by
monitoring the DEMAT activity of both
accounts.
P-NOTES AND NEW TAX TREATIES
As per the new tax treaty with Singapore and Mauritius coming into effect from April 1, 2017
inflows through P-Notes could see a sharp drop.
According to Securities and Exchange Board of India (SEBI) data, nearly 90 per cent of P-
note investments are routed through Singapore and Mauritius, with which the Indian
government has revised tax provisions.
According to the changed double taxation avoidance agreements (DTAAs), all investments
made from these jurisdictions would attract short-term capital gains as the exemptions would
get removed. Mauritius and Singapore are favoured by entities issuing P-Notes because of
tax-treaty benefits, particularly non-applicability of Indian laws.

6. 6
The new treaty says that capital gains that arise from shares purchased after April 1, 2017 by
foreign investors based in these countries can be taxed in India.
Accordingly, a capital gains tax of at least 7.5 per cent (There is, however, a 50 per cent
concession on the tax rate from April 1, 2017 to March 31, 2019) can be charged on short-
term gains from equity of investors from Mauritius and Singapore over the next two years
and 15 per cent after that. Investors will be taxed at the full domestic capital gains tax rate
from 2019-20.
The new treaty ensures open entry of investors which is not driven by tax exemptions but
sincere need for Indian equities.
Prepared By:-
Prachi Sharma
Counsel
www.rickychopra.co