Gains From Equity-Oriented Mutual Funds Not Taxable As 'Shares' Under Article 13(3A) of India-Mauritius DTAA: ITAT Delhi - 2025-06-25

ITAT Delhi: Gains on Mutual Funds Not 'Shares'; Not Taxable in India Under Mauritius DTAA

New Delhi: In a significant ruling clarifying the scope of the India-Mauritius Double Taxation Avoidance Agreement (DTAA), the Income Tax Appellate Tribunal (ITAT), Delhi Bench, has held that capital gains arising from the sale of equity-oriented mutual fund units are not taxable in India. The Tribunal, comprising Judicial Member Anubhav Sharma and Accountant Member Manish Agarwal, ruled that such gains do not fall under the definition of "gains from the alienation of shares" as specified in Article 13(3A) of the treaty.

The decision provides a major relief to foreign institutional investors (FIIs) routing investments through Mauritius, confirming that gains on mutual fund units are covered by the residuary clause, Article 13(4), which grants exclusive taxing rights to the country of residence (Mauritius).

Case Background

The case involved Emerging India Focus Funds, a Mauritius-based FII, which earned capital gains of over ₹593 crore in Assessment Year 2022-23 from selling equity-oriented mutual funds in India. The assessee claimed this income as exempt from tax in India under Article 13(4) of the India-Mauritius DTAA.

However, the Assessing Officer (AO) disagreed, contending that since the mutual funds primarily invested in Indian equities (minimum 65%), the transaction was effectively an indirect investment in the Indian share market. The AO invoked the "intent" of the 2016 Protocol amending the DTAA, which was to tax capital gains from shares. Consequently, the AO treated 65% of the gains (₹385 crore) as taxable in India under Article 13(3A).

The Dispute Resolution Panel (DRP) went a step further, directing that the entire capital gain was taxable, not just a proportion. The DRP applied the 'Doctrine of Purposive Construction' to argue that the legislature intended to treat units of equity-oriented mutual funds as equivalent to shares.

Key Arguments

Appellant's Contentions (Emerging India Focus Funds):

Strict Interpretation: The assessee, represented by Senior Advocate Ajay Vohra , argued for a strict interpretation of the DTAA. It was highlighted that Article 13(3A) specifically uses the word "shares" and not "units" or any language covering indirect investments.

Legislative Intent: If the treaty's framers had intended to include mutual funds or indirect holdings, they would have used explicit language, as seen in other treaties like the India-UAE DTAA.

Legal Distinction: Indian domestic law, including the Companies Act, 2013, and the Securities Contracts (Regulation) Act, 1956, clearly distinguishes between "shares" and "units of a mutual fund."

Grandfathering Clause: Without prejudice, it was argued that gains on units acquired before April 1, 2017 (amounting to ₹310 crore) were exempt under the treaty's grandfathering provisions, a point the DRP had directed the AO to verify.

Respondent's Contentions (Revenue Department):

Substance over Form: The Revenue argued that the assessee was effectively deriving benefits from the Indian equity market through an indirect instrument.

Purposive Interpretation: The DRP supported the view that the units of equity-oriented mutual funds "partake in the characteristics of shares" and are "akin to shares," as they derive value from an underlying portfolio of equities. It invoked the 'Doctrine of Purposive Construction' to align with the perceived legislative intent of the DTAA amendment.

Similar Treatment in Domestic Law: The DRP noted that domestic laws like Section 10(38) and 112A of the Income Tax Act provide similar tax treatment to both equity shares and equity-oriented mutual funds, suggesting they are analogous.

Tribunal's Analysis and Ruling

The ITAT overturned the findings of the lower authorities, emphasizing that principles for interpreting international treaties differ from those for domestic statutes.

"It is settled law that DTAA should be given an interpretation in which the reasonable meaning of words and phrases is preferred. Principles or rules of interpretation of a tax treaty would be relevant only where terms or words used in treaties are ambiguous, vague or are such that different meanings are possible. If words are clear or unambiguous then there is no need to resort to different rules for interpretation."

The Tribunal made the following key observations:

1. Distinct Legal Entities: The ITAT stressed the fundamental legal difference between shares and mutual fund units under Indian law. A 'share' represents an ownership interest in a company, governed by the Companies Act. In contrast, a 'mutual fund' is typically a trust, and its units represent an interest in a pooled investment vehicle regulated by SEBI.
2. No Room for Deeming Fiction: The Tribunal rejected the DRP's use of 'purposive interpretation' to equate mutual fund units with shares. It held that the Protocol amending the DTAA was specific to "shares," and this term could not be expanded by a deeming fiction to include other distinct securities.
3. Reliance on Precedents: The bench cited several judgments, including the Supreme Court's decision in Apollo Tyres Ltd vs. CIT and a Cochin Tribunal ruling in DCIT vs. K. E. Faizal , which established that mutual fund units cannot be treated as shares in the absence of a specific deeming provision.

"Thus there is no doubt left that under the Indian Laws, the shares and mutual fund both are different forms of securities... for the DTAA the gain on sale of Equity Mutual Funds cannot be said be out of alienation of ‘shares’."

Final Decision

The ITAT allowed the assessee's appeal, concluding that the capital gains from the sale of equity-oriented mutual fund units are not taxable in India under Article 13(3A) of the India-Mauritius DTAA. The gains fall under the residuary Article 13(4), making them taxable only in Mauritius. This decision reinforces the principle of literal interpretation for clear and unambiguous terms in tax treaties.