The Mumbai Bench of the Income Tax Appellate Tribunal recently pronounced a ruling in the case of 3 Sigma Global Fund Ltd.1, holding that the capital gains from the sale/ transfer of derivatives in the hands of Mauritius-based FPI are exempt from income tax under the residuary Article 13(4) of the India-Mauritius Double Taxation Avoidance Agreement (DTAA).
The case of the Revenue was based on the premise that derivatives are closely related to shares, and therefore, gains arising from the sale/ transfer of derivatives fall within the definition of taxable capital gains from shares under Article 13(3A) of the India-Mauritius DTAA.
This ruling is of particular importance for non-resident investors (including Foreign Portfolio Investors) investing in Indian capital markets through derivatives, debentures and other non-share instruments.
Key Findings of the Tribunal:
- The Tribunal distinguished derivative instruments from shares. Since the term “share” is not defined under the India-Mauritius DTAA and domestic tax law, the Tribunal resorted to the definition of the term under the Indian Corporate Law. Explaining the salient features of the instruments and the definition of the terms “share” under the Companies Act, 2017, and “securities” under the Securities Contracts (Regulations) Act, 1956, the Tribunal observed2:
- Derivatives fall under the definition of “securities” and not “shares”.
- Derivatives are separate financial contracts, distinct from the underlying asset.
- The underlying asset need not be shares.
- An investor is not required to own the underlying asset to trade in derivatives.
- Derivatives can be traded independently of the underlying asset.
- Article 13(3A) of the DTAA applies specifically to gains arising from shares (acquired on or after 1 April 2017) in Indian companies. Article 13(4), being a residuary clause, applies to gains from the alienation of any property not covered by Articles 13(1), (2), (3), or (3A). Derivatives, not being shares, will fall under Article 13(4) of the DTAA.
- In reaching to its conclusion, the Tribunal relied upon the press statement released at the time of signing the amending protocol to the India-Mauritius DTAA by the then Economic Affairs Secretary3, clarifying that the source-based taxation on gains from capital market transactions is limited to only shares, leaving out derivatives and debentures from its purview.
- Tribunal placed reliance on the rulings of Vanguard Emerging Markets Stock Index Funds v. ACIT (IT)4 and DCIT v. K.E. Faizal5, which essentially lays down the principle that rights/ mutual funds cannot be equated to shares.
- Lastly, the Tribunal invoked the principle of consistency, holding that Revenue cannot take a divergent position in different years without justification.
Interestingly, the Revenue also challenged the satisfaction of the Beneficial Ownership6 Test, dispelling the immunity available under the India-Mauritius DTAA. However, in the absence of a proper enquiry by the Revenue to substantiate the lack of substance and conduit conduct on the part of the taxpayer, the Dispute Resolution Panel dismissed the allegation made by the Revenue.
BMR Legal View:
The ruling reaffirms the established position that derivative instruments, despite their underlying link to equity shares, cannot be classified as “shares” for availing benefit under the DTAA, in general. The ruling renders interpretative clarity to investors investing from Mauritius (and DTAAs with other jurisdictions that have similarly worded provisions) to tax the gains in their Resident Country under the applicable Capital Gains Article for non-share-based instruments.
Interestingly, while the Tribunal’s ruling rejects the Revenue’s attempt to recharacterize derivatives as shares, the treaty benefit could come up for challenge on non-satisfaction of the Beneficial Ownership Test or the Principal Purpose Test, which wasn’t the purport of the enquiry in this case. The Ruling, for the time being, signals certainty for derivative trades.
1 M/s 3 Sigma Global Fund Ltd. v. ACIT (ITA No. 1130/MUM/2025)
2 Para 11 of the Ruling
4 [2025] (IT Appeal No. 4657 (Mum.) of 2023)
5 [2019] (IT Appeal No. 423 (Coch.) of 2018)
6 Para 3 of the Ruling refers to the Principal Purpose Test (PPT) invoked by the Revenue. The question of the validity of invoking the PPT was not raised before the Tribunal. In any event, given that Mauritius has not notified India-Mauritius DTAA to be a Covered Tax Agreement under the Multilateral Instrument Framework, in our view, PPT cannot be invoked in this case
To Know more, click: Intersections of Derivatives and DTAA Considerations: An Analysis of the Mumbai Tribunal’s Decision in 3 Sigma - BMR Legal