Introduction:
A Tax Treaty Shield That Still Works—If You Use It Right
In a welcome development for cross-border investors, fund managers, and tax professionals, the Income Tax Appellate Tribunal (ITAT) Mumbai has ruled that capital gains from derivatives earned by a Mauritius-based fund are not taxable in India, thanks to the protective shield of the India–Mauritius Double Taxation Avoidance Agreement (DTAA).
This judgment restores certainty for investors using derivative contracts—particularly those routed through Mauritius—by confirming that such gains fall outside the taxing ambit of India under Article 13(4) of the DTAA. It also marks a firm judicial stand against overreach by tax authorities attempting to recharacterize derivatives as shares for treaty override.
Case Reference
3 Sigma Global Fund vs. ACIT (International)
Citation: [2025] 176 taxmann.com 708 (Mumbai – Tribunal)
Assessment Year: Relevant to post-2017 transactions
Jurisdiction: Income Tax Appellate Tribunal, Mumbai Bench
Treaty Involved: India–Mauritius Double Taxation Avoidance Agreement (as amended by 2016 Protocol)
Case Background
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The assessee, 3 Sigma Global Fund, is a company incorporated in Mauritius, holding a valid Global Business Licence (GBL) and a Tax Residency Certificate (TRC) issued by the Mauritius Revenue Authority.
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The fund actively traded in equity and index derivatives on Indian stock exchanges, and reported the resulting gains in its Indian return of income as exempt under Article 13(4) of the India–Mauritius DTAA.
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The Assessing Officer (AO) denied this claim, invoking Article 13(3A) of the DTAA, arguing that derivatives are economically akin to shares.
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The Dispute Resolution Panel (DRP) upheld this interpretation. The assessee appealed to the Mumbai ITAT.
Legal Issue Framed
The dispute hinged on the correct interpretation of capital gains provisions under the India–Mauritius DTAA:
Do gains from derivative instruments fall under Article 13(3A) (which permits India to tax gains from shares acquired post-1 April 2017), or under Article 13(4) (which grants exclusive taxing rights to Mauritius for all other property)?
Statutory and Treaty Interpretation
1. Domestic Law Definitions
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Section 2(84) of the Companies Act, 2013 defines “shares” narrowly as shares in the share capital of a company.
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Section 2(81) defines “securities” broadly and includes derivatives.
Thus, while derivatives and shares both fall under "securities," they are legally distinct.
2. Nature of Derivatives
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A derivative is a financial contract whose value is derived from an underlying asset such as shares, indices, currencies, or commodities.
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The contract is independent of ownership in the underlying asset. There is no transfer of shares involved in derivative settlement.
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Trades are typically settled in cash based on market fluctuations.
Hence, no alienation of shares occurs—a key distinction for Article 13(3A) to apply.
3. ITAT’s Legal Reasoning
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The Tribunal held that the economic resemblance between derivatives and shares does not override the legal form.
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Treaty terms must be interpreted in accordance with their ordinary meaning, supported by domestic law, and consistent with the object and purpose of the treaty.
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Article 13(3A) specifically refers to “shares of a company”. Derivatives are not shares, and therefore, Article 13(3A) does not apply.
Instead, the Tribunal ruled that gains from derivatives fall under Article 13(4)—which governs capital gains from property not covered under prior paragraphs—and are taxable only in the residence state (Mauritius).
Final Ruling and Outcome
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The ITAT allowed the assessee’s appeal.
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It concluded that India has no taxing rights over derivative gains earned by a Mauritius resident.
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The assessment order was set aside, and treaty benefits under Article 13(4) were restored.
Implications for Mauritius-Based Investors
This ruling reinforces the following:
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Derivatives are distinct financial instruments, not “lookalike shares”.
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Valid Mauritius-based investors (with GBL and TRC) can claim full treaty protection on derivative gains.
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Article 13(3A) applies strictly to equity shares, not contracts linked to them.
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India’s right to tax such income is excluded by treaty, and cannot be extended by economic analogy.
Strategic Insights for Tax and Investment Advisors
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Fund structures that route derivative transactions through Mauritius retain DTAA protection, provided legal form is preserved.
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It is critical to maintain valid documentation—GBL, TRC, and transactional clarity—to withstand scrutiny.
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The ruling strengthens predictability and integrity in India’s international tax regime.
FAQs
Q1. Are derivative gains taxable in India if earned by a Mauritius company?
No. As per the ITAT ruling, such gains are taxable only in Mauritius under Article 13(4), not in India.
Q2. Do derivatives fall under Article 13(3A) of the DTAA?
No. Article 13(3A) applies only to shares. Derivatives, being distinct financial contracts, are covered under Article 13(4).
Q3. What conditions must a Mauritius fund meet to claim exemption?
The fund must hold a valid Tax Residency Certificate (TRC) and Global Business Licence (GBL) from Mauritius.
Q4. What if the derivatives are based on Indian stocks?
Even if linked to Indian stocks, no share ownership is transferred in derivative trades, hence no Article 13(3A) trigger.
Conclusion: A Judicial Reaffirmation of Legal Form and Treaty Protection
The ITAT’s decision in 3 Sigma Global Fund vs. ACIT is a landmark reaffirmation of treaty certainty. It sends a clear message that:
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Taxation must follow legal definitions, not economic equivalence.
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Treaty benefits cannot be denied arbitrarily by stretching interpretations.
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India remains committed to honoring treaty obligations for legitimate cross-border investments.
For international investors and advisors, this decision enhances clarity and encourages continued engagement with Indian markets through treaty-compliant routes.
