What Happened
- India and France signed an Amending Protocol on 24 February 2026 to update the 1992 Double Taxation Avoidance Convention (DTAC), coinciding with a state visit by France's President to India.
- The protocol deletes the Most Favoured Nation (MFN) clause from the DTAC, removing a long-standing provision that had allowed France to claim lower withholding tax rates if India offered better terms to any other OECD country.
- The amendment grants full source-country taxing rights over capital gains arising from the sale of shares in Indian companies.
- A Service Permanent Establishment (PE) provision has been introduced, making service activities in India that cross certain thresholds taxable in India.
- The protocol incorporates provisions of the Base Erosion and Profit Shifting (BEPS) Multilateral Instrument (MLI), including the Principal Purpose Test (PPT) to prevent treaty abuse.
- The change is expected to reduce inflows through participatory notes (P-notes) via the France route, which had become attractive after India amended its tax treaties with Mauritius and Singapore in 2016-17.
Static Topic Bridges
Double Taxation Avoidance Convention (DTAC) and Tax Treaty Architecture
A Double Taxation Avoidance Convention (DTAC) — also called Double Taxation Avoidance Agreement (DTAA) — is a bilateral treaty between two countries to ensure that income earned by residents of one country in the other country is not taxed twice. India has DTAAs with over 90 countries. These treaties allocate taxing rights between the source country (where income is earned) and the residence country (where the taxpayer is domiciled), and specify withholding tax rates on dividends, interest, royalties, and capital gains. DTAAs are negotiated under international frameworks including the OECD and UN Model Conventions.
- India's DTAA network: Over 90 countries
- Governing framework: Section 90 of the Income Tax Act, 1961 — empowers the government to enter into DTAAs
- Key DTAA provisions: Source vs. residence taxation; withholding tax rates on dividends, interest, royalties; capital gains allocation
- India-France DTAC originally signed: 29 September 1992
- Amendment protocol signed: 24 February 2026 (during French President's state visit to India)
Connection to this news: The amendment modernizes a 1992 treaty to reflect current international tax norms and closes a tax arbitrage opportunity that had been used by P-note investors routing through France.
Most Favoured Nation (MFN) Clause in Tax Treaties
The MFN (Most Favoured Nation) clause in bilateral tax treaties means that if country A gives more favorable tax treatment to country B (an OECD member) after signing a treaty with country C, then country C can claim the same favorable terms. In the context of the India-France DTAC, the MFN clause had been the subject of a landmark Supreme Court judgment in 2023 (Nestle India case), where the court held that mere entry of a country into OECD does not automatically trigger the MFN clause — the benefit must be explicitly notified. The deletion of the MFN clause resolves this uncertainty.
- MFN clause effect: Allowed France to import lower tax rates that India offered to other OECD members
- Supreme Court 2023 (Nestle India): MFN benefits not automatic; require government notification
- Amendment: Entirely deletes the MFN clause, eliminating future disputes
- MFN clause deletion aligns with India's broader policy of source-based taxation and BEPS compliance
Connection to this news: Removing the MFN clause closes the legal pathway that France-based P-note investors had used to claim lower withholding tax rates under the treaty, directly impacting P-note inflows.
Participatory Notes (P-Notes) and Foreign Portfolio Investment
Participatory Notes (P-Notes), also called Offshore Derivative Instruments (ODIs), are instruments issued by SEBI-registered Foreign Portfolio Investors (FPIs) to overseas investors who wish to invest in Indian securities without directly registering with SEBI. The issuing FPI holds the underlying Indian asset and passes on returns to the P-note holder. P-notes were extensively used in the 2000s (accounting for ~50% of FII investments at peak in 2007) but have declined sharply due to successive SEBI tightening, reaching just ~2.1% of FPI assets under custody in FY2024. France emerged as a preferred P-note jurisdiction after India amended its Mauritius and Singapore treaties in 2016-17.
- P-notes defined: ODIs issued by registered FPIs to unregistered overseas investors
- Regulated under: SEBI (Foreign Portfolio Investors) Regulations, 2014
- Peak usage: ~50% of FII investment in 2007; now ~2.1% of FPI AUC (FY2024)
- SEBI restrictions: Banned P-notes with derivatives as underlying assets; requires separate ODI registration; KYC and anti-money laundering compliance
- France route: Became popular after Mauritius and Singapore DTAAs were amended in 2016-17 to remove capital gains tax exemptions
- New amendment impact: Removal of MFN clause and full capital gains taxing rights in India eliminates tax advantage of routing P-note investments through France
Connection to this news: The India-France DTAC amendment closes the France P-note route by removing the MFN benefit and restoring India's full right to tax capital gains — consistent with India's broader direction toward source-based taxation.
Key Facts & Data
- India-France DTAC originally signed: 29 September 1992
- Amendment protocol signed: 24 February 2026
- Key change 1: MFN clause deleted (no more importing lower rates from other OECD treaties)
- Key change 2: Full capital gains taxing rights now vest in India (source country)
- Key change 3: Service PE provision introduced (services beyond threshold thresholds taxable in India)
- BEPS MLI provisions incorporated: Principal Purpose Test (anti-avoidance), anti-fragmentation rule, dependent agent PE update
- P-notes as % of FPI AUC: ~44.4% (FY2007) → ~2.1% (FY2024)
- Regulatory basis: Section 90, Income Tax Act, 1961 (enables DTAA signing)
- India's DTAA network: 90+ countries