PARTICIPATORY NOTES

•  Setting at rest the uncertainty about overseas investments, finance minister Pranab Mukhrjee has said those investing in stock markets through participatory notes (P-notes) will not have to pay tax in India, an assurance that pushed up the markets.

 What are Participatory Notes? 

•  Participatory notes (P-Notes) are derivative instruments issued by FIIs on Indian shares, but at a location outside of India.
• The investors, who buy P-Notes, deposit their funds in the US or European operations of the FII, which also operates in India. The FII then uses its proprietary account to buy stocks in India.
• Other types of P-Notes include equity-linked notes, capped return note, participatory return notes and investment notes. 

 Why do investors use P-Notes? 

• While one reason for using P-Notes is to keep the investor's name anonymous, some investors have used the instrument to save on transaction costs also. Such investors look for derivative solution to gain exposure in individual, or a basket of, stocks in the relevant market.
• Sometimes, investors enter the Indian markets in a small way using P-Notes, and when their positions become larger, they find it advantageous to shift over to a full-fledged FII structure. 

 What is the problem with the instrument? 

• It is difficult to establish the beneficial ownership or the identity of the ultimate investor, and hence cannot be taxed. It is feared that FIIs, which have to comply with know-your customer norms, know the identity of the investor to whom P-Notes are issued.
• Tax officials also fear that P-Notes are increasingly becoming a favourite among a host of Indian money launderers, who use the instrument to first take funds out of the country through the hawala route, and then get it back using P-Notes.