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We had organized a conference call today with ALMT Legal to seek its views on implications of the major amendments to the Direct Tax law proposed in the recent budget. Post the concall, we are of the view that transactions of FIIs routing money through tax havens like Mauritius (with or without P-Notes), which lack commercial substance, will be liable to tax in India under GAAR w.e.f April 01, 2012. The taxation rates are 15% on short-term gains and NIL on long-term gains, subject to payment of STT. Since taxation will be imposed on FIIs, we expect its impact to be passed on the ultimate beneficiary (P-Note holders).

An option to escape imposition of GAAR could be migrating operations to Singapore, since the Singapore treaty requires an FII to have a full-fledged commercial establishment. While for Bank FIIs who are already having significant operations in Singapore, it will be relatively easier to justify commercial substance vis-à-vis non bank FIIs who are not having significant operations there.

Further, the probability of direct taxation of gains arising out of P-Note transactions under Section 9 amendments (overseas transactions like Vodafone) looks remote since P-Notes are contractual in nature and do not constitute any transfer of shares/interest in any entity registered outside India. Since Section 9 is not applicable, the question of retrospective taxation is also ruled out.

Analysis Beyond Consensus - The P-Note dilemma