Gains from Derivatives based trading income not taxable in India but only in Mauritius

 Under Article 13(3A) of the India-Mauritius DTAA capital gains from the transfer of shares of an Indian company acquired by a Mauritius resident on or after 1 April 2017 are taxable only in India. Article 13(4) provides that capital gains from transfer of any other property not covered specifically under any other Para of the said article, are taxable in the country of residence of the transferor, i.e., Mauritius.

In a recent ruling, Delhi ITAT held that gains derived by a Mauritius-resident from trading in index-based derivatives on Indian markets cannot be equated with gains arising from transfer of shares. Recognizing derivatives as a distinct asset class separate from shares, the Tribunal ruled that such gains are taxable exclusively in the taxpayer's country of residence, i.e., Mauritius, and are therefore not subject to tax in India.

In the present case, the assessee, a Mauritius-based Foreign Portfolio Investor (FPI) earned short-term capital gains (STCG) from trading in index-based derivatives on Indian markets and claimed that these gains were not taxable in India under Article 13(4) of the India-Mauritius DTAA. AO however, sought to tax the gains in India by invoking Article 13(3A) of the DTAA, treating the derivative transactions as gains arising from the alienation of shares.

Assessee argued that derivatives and shares are legally distinct asset classes. Reliance was placed on the definitions contained in the Securities Contracts (Regulation) Act, which separately recognize shares and derivatives as different financial instruments. It was further submitted that the Income-tax Act also distinguishes between transactions in shares and derivatives, including under section 43(5). Accordingly, gains arising from derivative transactions could not be equated with gains from the alienation of shares. The assessee therefore contended that such gains fall within the scope of Article 13(4), the residuary capital gains provision under the DTAA, and are taxable exclusively in Mauritius.

Revenue argued that since DTAA does not specifically define the term "derivatives," a purposive interpretation should be adopted. According to the Revenue, Article 13(3A) should be interpreted purposively to cover gains from derivative transactions linked to Indian shares. Given that the value of derivatives is derived from underlying shares or stock indices, gains from such instruments should be treated at par with gains arising from the alienation of shares. It was further contended that the expression “alienation” should be interpreted broadly to include the transfer of economic benefits associated with shares through derivative instruments.

The Tribunal ruled in favour of the assessee and held that derivatives constitute a separate and distinct asset class from shares. This distinction is expressly recognized under the SCRA and is further supported by the separate treatment accorded to derivatives under the Income-tax Act. The Tribunal observed that gains arising from trading in index-based derivatives cannot be characterised as gains from the alienation of shares merely because the value of such instruments is linked to underlying shares or stock indices. Consequently, such gains fall within the residuary scope of Article 13(4) of the India-Mauritius DTAA and are taxable only in Mauritius, being the assessee’s state of residence.

The ruling underscores that derivative instruments are legally and commercially distinct from shares and therefore gains arising from their transfer cannot be brought within the ambit of treaty provisions specifically governing gains from the alienation of shares. It reinforces that treaty provisions specifically applicable to share transfers cannot be expansively interpreted to cover derivative transactions, which continue to be governed by the residuary capital gains provision under the treaty.