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Facts
The assessee, a Mauritius tax resident, traded in currency and stock derivatives. The Assessing Officer treated gains from stock derivatives as capital gains taxable in India under Article 13(3A) of the India-Mauritius DTAA, contrary to the assessee's claim of exemption. The Dispute Resolution Panel (DRP) concurred with the Assessing Officer.
Held
The Tribunal held that stock derivatives and shares are distinct assets, and gains from trading stock derivatives fall under Article 13(4) of the India-Mauritius DTAA, making them taxable only in the country of residence. However, grounds related to consequential interest and premature penalty proceedings were dismissed.
Key Issues
Whether gains derived from trading in stock derivatives are taxable as capital gains on shares under Article 13(3A) of the India-Mauritius DTAA, or fall under Article 13(4) and are taxable in the country of residence.
Sections Cited
143(3), 144C(13), 234A, 234B, 234C, 270A
AI-generated summary — verify with the full judgment below
Income Tax Appellate Tribunal, DELHI BENCH D : NEW DELHI
Before: SHRI VIKAS AWASTHY & SHRI BRAJESH KUMAR SINGH
This appeal by the assessee is directed against the assessment order dated 14th January, 2025 passed under Section 143(3) read with Section 144C(13) of the Income-tax Act, 1961 (hereinafter referred to as ‘the Act’) for the assessment year 2022-23.
2. The assessee in appeal has assailed the addition of Rs.60,42,042/- made by the Assessing Officer treating gain on trading of derivatives as capital gain on sale of shares.
Facts of the case in brief as emanating from the records are: The assessee is a quant multi strategy market-neutral dollar hedged fund and is a tax resident of Mauritius. The assessee trades in cross-listed securities in equity, commodity and currency derivatives. The assessee is registered as a Collective Investment Scheme (CIS) fund and constructs a hedged portfolio. The assessee is registered with SEBI as Category II Foreign Portfolio Investor. It filed its return of income for the assessment year 2022-23 on 7th November, 2022 declaring total income of `1,32,75,000/-. During the period relevant to assessment year under appeal, the assessee had traded in Futures and Options (F&O) in two segments i.e. (i) currency derivatives, and (ii) stock derivatives. The Assessing Officer accepted F&O transactions in currency derivatives are covered under Article 13(4) of India-Mauritius DTAA, hence, not taxable in India. As regards stock derivatives, the Assessing Officer held that the assessee has invested in shares via derivatives. After amendment to India-Mauritius DTAA, share based capital gains are taxable in India under Article 13(3A) of the DTAA and thus, rejected assessee’s arguments that gain on trading of stock derivatives is exempt. The assessee filed objections before the DRP against the draft assessment order. The DRP concurred with the Assessing Officer’s view and upheld the addition. Thereafter, the Assessing Officer passed the final assessment order giving effect to findings of the DRP. Hence, the present appeal.
4. Shri Sanjeev Kapoor, learned Counsel appearing on behalf of the assessee submits that the Assessing Officer and the DRP have erred in holding stock derivative transactions and trading in shares are one and the same. The learned Counsel submits that the Assessing Officer and the DRP have misconstrued that stock derivatives are taxable as capital gain under Article 13(3A) of India-Mauritius DTAA. To substantiate his argument that trading in shares and trading in stock derivatives are two different transactions, he placed reliance on following decisions:
(i) Vanguard Funds Public Limited Company Vs. ACIT; 173 taxmann.com 321 (Mumbai- Trib); (ii) Sapein Funds Ltd., Mauritius Vs. CIT; 153 taxmann.com 60 (Delhi- Trib)
5. Per contra, Shri M.S. Nethrapal, representing the Department vehemently defended the impugned order and submitted that stock derivatives are akin to shares as the stock derivatives draw their value from underlying shares. Therefore, stock derivatives are nothing but shares which are covered under newly-inserted Clause (3A) to Article 13 of India-Mauritius DTAA. The learned DR reiterated findings of the Assessing Officer and the DRP. Thus, he prayed for upholding the impugned order and dismissing appeal of the assessee.
Both sides heard. Orders of the authorities below examined. The solitary issue for adjudication in the present appeal is; whether gain arising on transactions of stock derivatives result in capital gains taxable under Article 13(3A) of India-Mauritius DTAA. Insofar as the tax residence status of the assessee, there is no dispute. The assessee is a registered Foreign Institution Investor. The assessee, during the period relating to assessment year under appeal, undertook transactions in currency derivatives and stock derivatives and claimed the gain on said transactions as not taxable in India. The Assessing Officer accepted that gain from currency derivatives is exempt under Clause 4 of Article 13 but held that gain on stock derivatives are covered by Clause 3A of Article 13, hence, taxable in India.
We find that the Assessing Officer and the DRP have held trading in stock derivatives are the same as trading in shares, the underlying asset in trading of derivatives are the shares. The basic approach and understanding of the Assessing Officer and the DRP in treating transaction in stock derivatives akin to transaction of shares is faulty. Here it would be imperative to first understand the fundamental difference between derivatives and equity shares. For convenience of understanding the difference between the two, a comparative analysis on various factors is tabulated herein below:-
S.No. Factors Equity Derivatives 1. Meaning Represents Financial contracts that derive ownership in a value from an underlying asset company. like stocks, indices or commodities.
Purpose Ideal for long term Used for hedging, speculation, investing and or leveraged trading. wealth creation.
3. Ownership Shareholding with No ownership – only rights or ownership rights. obligations tied to price movements.
Risk Level Moderate, and High due to leverage, volatility, usually lower than and expiry pressures. derivatives.
5. Holding Short term to Long Limited to weekly or monthly Period term. expiries.
6. Returns Grows steadily with Potentially very high, depending company on type of derivatives and performance leverage used. through capital appreciation and dividends.
7. Regulation Fewer regulatory Stricter controls on margin and constraints; risk due to leverage. simpler trading structure.
8. Complexity Relatively straight Complex as the value depends forward with their on various factors like value tied with underlying asset, contract company’s terms expiry and leverage. performance.
The above differences clearly brings out that shares and derivatives having shares as underline assets are two distinct assets.
In the case of Vanguard Funds Public Limited Company (supra), where the assessee a Foreign Portfolio Investor earned short term capital gain on sale of Rights Entitlement (RE) of shares of Indian company claimed the same as not taxable under Article 13(6) of India -Ireland DTAA, the Assessing Officer held that RE and shares are closely related assets, hence any gain on transaction of RE would be taxable in India under Article 13(5) of the DTAA. The issue travelled to the Tribunal. The Coordinate Bench held: “20. To buttress this point of distinction, ld. Counsel for the assessee referred to clarification issued by the then Economic Affairs Secretary in respect of amendment to the India-Mauritius DTAA. In 2016, the India-Mauritius DTAA was amended which re- allocated the taxation rights in respect of sale of shares between India and Mauritius. Pursuant to the amendment, India gained rights to tax gains arising on sale of share of Indian companies. At the time some ambiguity was perceived with regards to applicability of the amended provisions to gains arising on sale of other capital assets. The Government's stand was clarified by then Economic Affairs Secretary Mr. Shaktikanta Das to “Business Standard” news paper which has been quoted verbatim in an news article dated 21 August 2015, reproduced as under:- "Derivatives and other forms of securities, such as compulsory convertible debentures (CCDs) and optionally convertible debentures (OCDs) will continue to be governed by the existing provision of being taxed in Mauritius, said economic affairs secretary Shaktikanla Das. He said India had gained a source- based taxation right only for shares (equity) under the treaty Residence-based taxation will continue for derivatives under the Mauritius pact Meaning non-equity securities would be taxed in Mauritius if routed through there. But Mauritius does not have a short-term capital gains tax which would mean that investors using these instruments would continue to escape paying taxes in both countries. "There are three categories of instruments which arise between two countries-shares, immovable assets, and other instruments, including derivatives," he explained. "Insofar as shares are concerned, they are covered by the new agreement. As regards immovable property, all along the right to taxation is in India. The right to taxation is in the country where an immovable asset is located. So, if an immovable asset is located in India, we have the taxation right. With regard to other instruments, "the right to tax is always in that country. There cannot be a change that is the position all over the world". "It is their country's decision The right to tax is with that country with the US, the UK, Germany, Japan, Mauritius, all the countries (with which India has a Double Taxation Avoidance Agreement), It is for that country to decide whether it wants to tax at 10, 20, or zero per cent (And) Just because some country has made it zero, I can't say I will tax, he further clarified"
Accordingly, it has been argued before us that even the stand of Government of India (through its Secretary in press) is that “shares would cover “shares of Indian Company” and not derivatives & other securities. Accordingly, gain on alienation of securities other than shares would continue to be taxed in the resident country and not in India. The aforesaid clarification, clarifying the stand of the Government of India, if we look from the perspective of the distinction between the shares and other securities, then for the purpose of the present case, the rights entitlement which is distinct from shares can be taken as a guidance to see the intention of the Government while negotiating or amending the Articles of DTAA.
It is also a well settled proposition of law if any term has not been defined under the Act or treaty; the same is to be understood as per the domestic legislation in view of Section 90(3) of the Act as well as Article 3(2) of India-Ireland DTAA. It states that where the term has not been defined under the treaty, the meaning under the domestic tax legislation is to be adopted. Further, where the term has not been defined in domestic tax legislation also it is a general meaning is to be adopted. We find that the definition of shares even in Section 2(84) of the Companies Act, 2013 provides a restrictive definition of shares to mean a share in the share capital of a company and includes stock. Otherwise also an asset, which may come into existence or derive its value from another underlying asset, cannot be regarded as being same as the original asset. An analogy may be drawn to a „derivative‟, which may derive its value from the underlying equity but it is a well-established principle that the derivative contract is a distinct and separate asset. Under the India-Ireland DTAA a derivative deriving its value from underlying equity would not be subject to tax in India under Article 13(6). Likewise rights entitlement which is granted on account of shareholding cannot be regarded as being the same as shares especially since the rights shares are allotted, only on subscription. The rights entitlement, being a distinct asset, may be sold lapsed or subscribed and thus, akin to derivatives, ought to be not subject to tax under Article 13(6) of the India-Ireland DTAA. Similarly, the investor can either sell the rights entitlement option or exercise the option to get shares or decline the offer for shares.
Hence, in our opinion, rights entitlement would also be covered under the provisions of Article 13(6) of India Ireland DTAA and in that case it would not be subjected to tax in India but it shall be taxable in the resident state i.e. Ireland.”
Thus, the Tribunal concluded that shares and RE are separate and distinct assets. They fall under Articles 13(6) of India- Ireland DTAA. Any gain on sale of RE would be taxable only in the state of residence.
Here it would be imperative to refer to the provisions of India- Mauritius DTAA. The relevant clauses of Article 13 dealing with ‘Capital Gains’ are extracted below:
“3A. Gains from the alienation of shares acquired on or after 1st April 2017 in a company which is resident of a Contracting State may be taxed in that State. 3B xxx 4. Gains from the alienation of any property other than that referred to in paragraphs 1, 2, 3 and 3A shall be taxable only in the Contracting State of which the alienator is a resident.
For the purposes of this article, the term "alienation" means the sale, exchange, transfer, or relinquishment of the property or the extinguishment of any rights therein or the compulsory acquisition thereof under any law in force in the respective Contracting States.” A bare reading of clause 3A would show that it only refers to “shares”. As explained above Shares and Derivatives are two distinct and separate assets. Clause 4 makes it clear that any other property not mentioned in Clause 3A would be taxable in the State of residence. The provisions of Clause 3A and 4 of India- Mauritius DTAA are pari materia to Clause 3 and 5 of India Ireland DTAA.
We find that the Tribunal in the case of 3 Sigma Global Fund vs ACIT, International reported as 176 taxmann.com 708 (Mumbai- Trib), in similar set of facts where the AO had treated transaction in Derivatives at par with sale of shares and taxed gain on sale of derivates in India under Article 13(3A) of India Mauritius DTAA, the Tribunal after placing reliance on the decision of Vanguard Funds Public Ltd. Company (supra) held as under: “10. Accordingly the moot question before us is whether Derivatives are shares the alienation of which is taxable under Article 13(3A) or whether Derivatives are other than shares to be taxed as per Article 13(4) of the India-Mauritius DTAA. Section 2(84) of the Companies Act defines shares as "a share in the share capital of a company and includes stock.". The owner of the shares has various rights including voting right. Though the term Derivatives is not defined anywhere, the term "securities" defined under section 2(81) of the Companies Act as per clause (h) of section 2 of the Securities Contracts (Regulations) Act, 1956 (42 of 1956) includes derivatives. Therefore it is clear that as per the Companies Act, shares and derivatives are considered as separate assets. Before deciding whether shares and derivatives are difference, we will first examine what is a derivative and its salient features.
In general parlance Derivative is a financial contract between parties whose value is derived from the changes in the value of underlying assets. The underlying assets can be in the form of shares, bonds, commodities like gold or silver, currencies, interest rates and market indices. In layman language a typical derivative contracts is where the parties involved enter into contract to buy/sell the underlying asset at a particular price at an agreed future date in order to mitigate the risk of price fluctuation of the underlying asset. The derivative contract is a complex financial product that gets traded in the exchange or over the counter and the investor earns profits or ends up in making loss without actually buying or selling the underlying asset. For example in order to avoid the risk of movement in fuel price a contract would be entered into between parties to buy / sell the fuel at a fixed price at a future date in order to protect the risk of fuel price fluctuation. This contract is a derivate whose price would move up or down depending on the movement in the fuel price and is traded in the market as it is. The investor of the derivative would end up in making profit or loss without actually buying or selling fuel depending on the price movement of the fuel. Derivative trade offers leverage to the investor to have control over a large asset portion with a relatively small initial investment since the investor may not actually buy or sell the underlying asset. This financial leverage comes with risk of significant gain or loss situation which makes Derivative high-risk, high rewarding instrument. The following key features of Derivative emanate from the above high level understanding - • That derivates are a financial contract different from the underlying asset • That the underlying asset can be anything and not only shares • That in order to trade in derivatives, the investor need not own the underlying asset • That the derivative contract being a separate financial instrument can be traded as it is without buying or selling the underlying asset (as explained in the above example) 12. A combined perusal of the above discussed nature of derivatives, the definitions of "shares" and "securities" under the Companies Act, and the relevant observations of the coordinate bench in the case of Vanguard Emerging Markets Stock Index Funds (supra) makes it clear that derivatives are assets that are different from shares and accordingly we see merit in the contention that gain from alienation of derivatives need to be considered under Article 13(4) of the India-Mauritius DTAA. This view is supported by the observations of the Revenue Secretary's clarification in Media while amending the India-Mauritius DTAA with regard to taxability of the assets other than shares and immovable property under the Treaty.” [Emphasized by us] From the decisions referred above, it would be evident that trading in stock derivatives and trading in shares is not one and the same. Gain from trading in derivatives, even though the underlying asset may be shares, cannot be treated as gain from trading in shares. Therefore, the provisions of Article 13(3A) would not get attracted. Article 13(3A) of India-Mauritius DTAA only refers to gain from alienation of shares. It does not in any manner include gain from trading of derivatives. The gain from trading of derivates are covered by Clause 4 of Article 13, hence, taxable in the Country of residence.
11. Thus, in light of the facts discussed above, we find merit in the submissions of the assessee. The assessee succeeds on ground Nos.1 to 3 of the appeal.
In ground No.5 of appeal, the assessee has assailed charging of interest under Section 234A, 234B and 234C of the Act. Levy of interest under aforesaid sections is consequential and mandatory, hence, ground No.5 of the appeal is dismissed.
In Ground No.6 of appeal, the assessee has assailed initiation of penalty proceedings under Section 270A of the Act. Challenge to penalty proceedings at this stage is premature, hence, ground No.6 is dismissed as premature.
The remaining grounds of appeal are general in nature, hence, require no separate adjudication.
In the result, the appeal of the assessee is partly allowed.
Order pronounced in the open court on Thursday the 12th day of March, 2026.