The Budget has failed to provide any tax relief to non-resident holders of offshore derivatives instruments (ODIs), or P-Notes, issued by non-bank entities from Gift IFSC.

In May, the International Financial Services Centres Authority (IFSCA) had allowed non-bank entities registered with the Securities and Exchange Board of India as foreign portfolio investors (FPIs) to issue ODIs with Indian securities as underlying at Gift-IFSC. Till then, only foreign banks could issue such ODIs.

At present, section 10(4E) of the Income-Tax Act provides an exemption to non-resident ODI holders in the case of transfer or distribution of any income earned on derivative instruments contracts entered with IFSC banks.

“The omission of extending section 10(4E) tax exemptions to non-residents dealing with non-bank entities in IFSC creates disparity and uncertainty. Ensuring tax clarity akin to that provided for IFSC banks is very much needed to develop this product segment,” said Jaiman Patel, Partner, EY India.

“Non-bank entities at Gift IFSC such as broker dealers and fund managers have been allowed to issue P-Notes to overseas investors. No corresponding amendment, however, has been made in this Budget to provide tax exemption to these subscribers. A relaxation in tax law should be considered soon in order to boost further investments through this route, especially in debt instruments,” added Rajesh Gandhi, Partner, Deloitte India.

The tax relief will also provide certainty under domestic tax laws as against relying on treaty benefits for ODI structures done outside India that are subject to onerous conditions, said experts.

For instance, those writing an ODI from UK have to rely on the UK treaty to take the tax benefit on interest income and dividend. Tax authorities, at a later stage, can potentially deny the tax benefit on the pretext that the investor is not the beneficial owner. Coming through Gift IFSC, however, provides an added layer of certainty as treaty-abuse and indirect transfer provisions do not apply and there are no capital gains to he paid on the debt investment.

The Budget 2023 had amended Section 18A of Securities Contract Act, 1956, to provide that ODI contracts issued by FPIs in GIFT IFSC and regulated by the IFSCA will be valid and legal contracts.

P-Notes accounted for 2.14 per cent of the total assets under custody of FPIs at the end of March this year.