Taxability of Derivatives – Article 13(4) of India-Mauritius DTAA

3 Sigma Global Fund Vs ACIT (ITAT Mumbai)

Background: The Mumbai Income Tax Appellate Tribunal (ITAT) recently delivered an important decision in the case of M/s 3 Sigma Global Fund v. ACIT concerning the taxability of gains arising from derivative transactions undertaken by a Mauritius-based Foreign Portfolio Investor (FPI). This decision clarifies the applicability of the India–Mauritius Double Taxation Avoidance Agreement (DTAA) to derivative instruments, providing helpful precedent for similarly placed taxpayers.

1. Facts

• The assessee, 3 Sigma Global Fund, is a Mauritius-incorporated entity holding a valid Tax Residency Certificate (TRC).
• During Assessment Year 2022–23, the assessee declared:
  • Short-term capital gains on shares: ₹17.80 crore
  • Income from derivatives: ₹1.88 crore
  • Dividend income: ₹0.24 crore
• The assessee claimed exemption of derivative income under Article 13(4) of the India–Mauritius DTAA.
• The Assessing Officer (AO):
  • Denied treaty benefits applying the Principal Purpose Test.
  • Taxed derivative income in India under Article 13(3A), treating derivatives as akin to shares.
• The Dispute Resolution Panel (DRP):
  • Allowed the benefit of the DTAA generally but upheld the taxation of derivatives in India under Article 13(3A).
• The assessee appealed to the ITAT.

2. Relevant Legal Provisions

• Article 13(3A) of the India–Mauritius DTAA:
  • Taxation rights over gains from the alienation of shares acquired on or after 1 April 2017.
• Article 13(4):
  • Gains from alienation of property other than shares or immovable property are taxable only in the country of residence.
• Companies Act, 2013:
  • Section 2(84): Defines “shares” as interest in share capital.
  • Section 2(81): “Securities” include derivatives.
• Principle of Interpretation:
  • Undefined treaty terms are interpreted per domestic law (Article 3(2) DTAA).

3. Assessee’s Contentions

• Derivatives are distinct from shares:
  • They are financial contracts derived from underlying assets.
  • No voting rights or control.
  • Limited life and expiry features.
• Gains should fall under Article 13(4) and thus be exempt in India.
• The Revenue Secretary’s public clarifications during the 2016 DTAA amendments confirmed that derivatives remain taxed in Mauritius.
• In the prior year (A.Y. 2023–24), the AO had accepted the same position.
• The assessee cited judicial precedents reinforcing the distinction between derivatives and shares.

4. Revenue’s Contentions

• Derivatives are economically linked to shares.
• Accordingly, gains should be taxed in India under Article 13(3A) as gains from “shares.”

 5. Tribunal’s Conclusion