Morgan Stanley shifts base for p-notes

Move on Indian securities follows changes to DTAA

Financial services firm Morgan Stanley has started issuing participatory notes (p-notes), or offshore derivative instruments (ODIs), on Indian securities from France instead of Singapore, following changes to the Double Taxation Avoidance Agreement (DTAA), said sources familiar with the development.

However, the brokerage has not shut Singapore operations, as a substantial amount of pnotes issued from there are still active. All incremental ODIs starting January 1 are being issued from France, which offers better tax advantage, said a source. P-notes are financial instruments that allow overseas investors to take exposure to the Indian market without having to register with the Securities and Exchange Board of India.

The development brings to light several loopholes in the current regulations, including newly-implemented General Anti-Avoidance Rules (GAAR).

“This shift by Morgan Stanley comes even as the Indian government has tightened the policy framework around foreign portfolio investors (FPIs) selecting a jurisdiction based purely on tax reasons. Morgan Stanley has gone ahead with the movement, though another top foreign brokerage red-flagged the issue with the finance ministry in August 2016,” said a source.

In 2016, Morgan Stanley Singapore was the largest p-note issuer in the country, with a market share of 14.3 per cent, followed by Copthall Investments, a subsidiary of JP Morgan, with a share of 11.2 per cent.

“Given the new terms of the DTAA, it is a rational decision by Morgan Stanley from the business point of view. Although such a transition is majorly based on tax concerns, there is nothing much the Indian authorities can do. Morgan Stanley has enough establishments in France to suffice all the conditions of Gaar,” said a source.

GAAR provisions empower the Indian authorities to declare an arrangement as an “impermissible avoidance arrangement” if the main purpose of the agreement is to obtain “tax benefit”. However, to decide if an arrangement is for tax benefit or not, taxmen rely on tests like commercial substance. These tests take into consideration the establishment, set-up, employees, and business activities of the firm in the new jurisdiction to arrive at a conclusion. Firms like Morgan Stanley can easily fulfill these, as they have pan-global presence and have permanent establishments across major global markets, including France.

“GAAR gives considerable power to Indian authorities to penalise the investors who choose a jurisdiction solely based on tax considerations. Having said that, about half a dozen big FPIs, which have a pan-global presence, might still be able to manage such a movement, as they have establishments around the world,” said Tejesh Chitlangi, partner, IC Universal Legal.

The government has also signed multilateral instruments (MLIs) as part of the base erosion and profit shifting convention, to further tighten the policy framework around tax evasion by foreign institutions and multinational companies (MNCs). The instruments are aimed at institutions that avoid tax through the strategic use of cross-border shifting of profits.

Although conditions under MLIs are relatively stringent compared to domestic antiavoidance rules, invoking MLIs does not seem an option for the government at this point, as there are still plenty of uncertainties around the framework. To begin with, MLIs don’t have the complete legal status yet and in order to provide legal sanctity, the government will have to tweak several laws, including the Income Tax Act.

Also, MLIs are monitored through the Organisation for Economic Co-operation and Development, an inter-governmental body. Hence, until all the signatories make necessary changes to their domestic laws, the extent of enforceability of these agreements remains unclear, tax experts said.