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MUMBAI (Reuters) - Societe Generale and BNP Paribas are wooing hedge funds to invest in India through France, noting a special treaty between the two countries that allows investors to avoid paying tax in one of the world's hottest emerging markets.
The banks point out to investors that routing investments through their Paris base, where they have existing structures in place, would cushion them against the impact of a sweeping revamp in Indian tax rules - the General Anti Avoidance Rule (GAAR) - which came into effect this month, six people with knowledge of the banks' communications told Reuters.
Those people noted that investing in India via France, while legal, could prove controversial with Prime Minister Narendra Modi's government, which is targeting foreign investments that avoid Indian taxes by coming through countries with special tax treaties.
Also, the two French banks are promoting investments into so-called participatory notes, or P-notes - products created by banks to track Indian shares, debt and derivatives - the people said.
A government-appointed panel warned in 2015 that P-notes could lead to "misuse", including money laundering or the channelling into domestic markets of unaccounted wealth held by Indians abroad.
In response to Reuters queries, Societe Generale said it is "fully committed to preventing tax fraud and evasion."
"We comply with local regulations in countries where we operate. This includes SEBI's regulation on the distribution of Indian P-Notes to eligible investors," it added, referring to the Securities and Exchange Board of India.
A spokeswoman for BNP Paribas said: "We deny the assertion that we have promoted investment via France as a way to avoid CGT (capital gains tax)."
"BNP Paribas complies with all ODI (offshore derivative instruments) regulations as issued by SEBI and the applicable tax rules including GAAR... Our global set-up to provide market access products has remained consistent in all countries where we operate, including in India, and has not changed in response to the recent amendments to Indian regulations."
A spokesman for India's finance ministry declined to comment.
Amit Maheshwari, a senior tax consultant, said he had been approached by clients who were contacted by the two French banks, but had advised caution.
"P-notes will definitely be a big concern because the government doesn't want to promote them," he said, adding also that the government would likely be concerned if funds were steering investments via France.
"The Indian government now wants their fair share of taxes, and this is something which will create ripples with the tax authorities," Maheshwari said, adding he expected New Delhi would push for a renegotiation of its tax treaty with France.
The treaty was one of several India signed in the 1980s and 1990s when it sought to attract overseas capital. It has similar double taxation avoidance deals with countries such as The Netherlands, Spain and Sweden.
The banks say "there is no way the Indian government can challenge us under GAAR, so why don't you use our route? You will not pay any tax," said another senior official at a tax and consulting firm who said he was approached by clients who received emails from BNP and Societe Generale.
Reuters could not independently verify the content of the banks' emails to potential clients. Other tax consultants, a hedge fund and a banker spoke to Reuters on the issue on condition they were not identified.
Under Modi, India has begun amending tax treaties with other countries in an attempt to clamp down on what it sees as abuse of its domestic tax rules.
It has already amended treaties with Singapore and Mauritius, which together account for around a third of foreign direct investment into India, including portfolio investments.
Those agreements phase in higher CGT over two years, rising to the full 15 percent tax rate India imposes on short-term capital gains on shares and 30 percent on futures and options. Investments held longer than 12 months are not taxed.
That makes France, ranked only ninth among the sources of foreign capital coming to India in April-December last year, a relatively attractive investment route - as investors would not have to pay any short-term CGT in India as long as the investment held is less than 10 percent of a company's share capital.
India is attracting foreign investment on hopes for an improving economy and more reforms. Its NSE share index is up more than 13 percent this year to a record high and the rupee currency is at a near-1-year high.
Investing in India via France carries the risk that India could at any time seek to amend the tax treaty. And New Delhi has some leverage given France is keen to boost defence sales to India, such as its Rafale fighter jets.
($1 = 64.9600 rupees)
Additional reporting by Maiya Keidan in LONDON; Editing by Ian Geoghegan