Participatory Notes, also known as P-Notes, are used by foreign investors who don’t want to register themselves with Indian Capital market regulator SEBI directly but still wish to invest in Indian stock market. The brokers buy India-based shares or bonds and then issue corresponding participatory notes to investors in return. Usage of P-Notes is restricted to foreign investors only.
The use of P-Notes gained much popularity in the 1990s, as a tool for foreign investment into India. P-Notes became popular due to two reasons
It was a very simplified process of investment where the actual P-Note holder had very less disclosure requirements
There was tax exemptions on the capital gains because of the double taxation avoidance agreement which existed between Mauritius and India
Using P-Notes, Foreign investors are able to invest in Indian stock markets easily
P-Notes helps investors to hide their actual identify as disclosure is not required for this transaction
FIIs are those who invest in the assets belonging to a different country other than that where these organizations are based. To buy Indian Securities they require a PAN card and other mandatory documents as per the guidelines prescribed by SEBI and Government of India. One example is HSBC, it buys certain Indian shares/bonds on behalf of investors and keep those shares in HSBC’s account and issues the receipt to investors about share purchased on their behalf which is called as Participatory Notes.
Disadvantages/Challenges/Limitations of P-notes:
P-Notes are being used by Indian tax evaders black money laundering from other countries by pumping it back into Indian securities. Due to hidden identity it becomes difficult to track the same.
Also a foreign entity can convert illegal money into white money, as it is difficult to get to know whether the investment is on behalf of FII or it is an investment by a foreigner. FII will invest the money and issues P-Notes, so it will get the benefit without directly holding any security.
It has become cause of discrimination as local investor has to fill forms, provide PAN card details etc to invest in Indian stock market which is not the case for P-Notes
Considering very large investments coming through P-Notes in India, SEBI is cautious in imposing any new restrictions as that might dry up liquidity in Indian stock markets.