We are a UK company registered as an FII, trading index and stock futures and options on Indian exchanges through brokers and custodians. Is that income taxable in India?
No. The Authority ruled that the income derived by Morgan Stanley and Co. International Limited, a UK resident, from trading in exchange-traded derivative instruments in India would not be taxable in India under the India-UK agreement. It held first that income from derivative trading is business income and not capital gains, derivative contracts being excluded from the definition of capital asset. Business profits are taxable in India only through a permanent establishment, and the brokers, custodians and bankers the applicant used were independent agents acting for many clients in the ordinary course of their business, so no permanent establishment arose under article 5. The ruling binds only that applicant.
Pronounced by the Authority for Advance Rulings (Syed Shah Mohammed Quadri, J. (Chairman) and K. D. Singh, Member) on 2004-11-29, reported as [2005] 272 ITR 416 (AAR); (2005) 193 CTR (AAR) 161. It bears on section 2(14), section 45, section 28, section 90, section DTAA art 7, section DTAA art 5, section DTAA art 14 of the Income Tax Act 1961, in Capital Gains and Residence & Treaty Benefit matters.
This is an early considered AAR treatment of derivative income earned by a foreign institutional investor, and it is useful for the sequence rather than the result. Characterisation comes first, and the Authority reasoned it from the nature of the instrument: an exchange-traded future or option has a life of about three months, carries no voting rights and involves no capital investment of the kind a share does, so a programme of trading in them is a business and not the realisation of investments. Placing the income in article 7 then made the permanent establishment question decisive, and the independent-agent finding on brokers and custodians did the rest. Both limbs need rechecking today - section 2(14) has since spoken directly to securities held by FIIs, and the India-UK agreement has moved on.
Binding only on the applicant who sought it, in respect of the transaction the ruling was sought on, and on the Principal Commissioner or Commissioner and the authorities subordinate to him in respect of that applicant and that transaction — and only until the law or the facts change (section 245S). It binds nobody else. The Tribunal and the courts nonetheless treat a considered ruling as persuasive, which is why practitioners cite them.
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Morgan Stanley and Co. International Limited was incorporated in and a tax resident of the United Kingdom, and was registered with the Securities and Exchange Board of India as a Foreign Institutional Investor. It already traded in exchange-traded derivative instruments in India and proposed to expand that business. The instruments were index and stock futures and options, traded on Indian exchanges through brokers, with custodians and bankers acting as independent service providers. The contracts had a life of roughly three months, carried no voting rights and required no initial capital investment of the kind an equity holding does, and the annual volume of transactions was substantial, of the order of Rs 3,932 crores. A single question was put: whether the income derived by the applicant, a company incorporated in and tax resident of the United Kingdom, from trading in exchange traded derivative instruments in India would be taxable in India having regard to the provisions of the double taxation avoidance agreement between India and the United Kingdom.
The Authority ruled that the income would not be taxable in India. It reached that in stages. Income from transactions of trading in derivatives is business income and not capital gains, derivative contracts being excluded from the definition of a capital asset, so the receipts fell to be dealt with under the business profits article and not under the capital gains article. Business profits of a UK enterprise are taxable in India only if earned through a permanent establishment situated here. The brokers, custodians and bankers through whom the applicant operated were agents of an independent status, acting for many clients in the ordinary course of their own businesses, and an enterprise is not deemed to have a permanent establishment merely because it carries on business through such agents. No permanent establishment therefore existed under article 5 of the India-UK agreement, and the income derived by the applicant from trading in exchange traded derivative instruments in India would not be taxable in India.
The Authority worked from the instrument outwards. An exchange-traded future or option is not a holding in a company: it confers no voting rights, requires no subscription of capital, and expires within months. Reading the definition of capital asset with the related definitions in section 2, it concluded that derivative contracts do not answer that description, so a surplus on closing them out cannot be a capital gain. What remained was a systematic, high-volume programme of buying and selling for profit, which is trade. That characterisation was the pivot of the ruling, because the India-UK agreement treats capital gains and business profits quite differently: capital gains would have been open to taxation in India, whereas business profits are reserved to the residence State unless attributable to a permanent establishment in the source State. The Authority then applied the ordinary agency test. The applicant had no fixed place of business in India, and its presence in the market was entirely through brokers who executed its orders, custodians who held its securities and bankers who moved its money. Each of those was carrying on its own business, for a general clientele, and none acted exclusively for the applicant or bound it to contracts. Paragraph 5 of article 5 protects an enterprise operating through such agents, and the Authority held it applied. With the income in article 7 and no permanent establishment, India had no taxing right.
The income derived by the applicant from trading in exchange traded derivative instruments in India would not be taxable in India.
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Handle my notice → Ask a CA on WhatsAppNo. The Authority ruled that the income derived by Morgan Stanley and Co. International Limited, a UK resident, from trading in exchange-traded derivative instruments in India would not be taxable in India under the India-UK agreement. It held first that income from derivative trading is business income and not capital gains, derivative contracts being excluded from the definition of capital asset. Business profits are taxable in India only through a permanent establishment, and the brokers, custodians and bankers the applicant used were independent agents acting for many clients in the ordinary course of their business, so no permanent establishment arose under article 5. The ruling binds only that applicant. This was decided by the Advance Ruling (Syed Shah Mohammed Quadri, J. (Chairman) and K. D. Singh, Member) and bears on section 2(14), section 45, section 28, section 90, section DTAA art 7, section DTAA art 5, section DTAA art 14 of the Income Tax Act 1961. It is reported as [2005] 272 ITR 416 (AAR); (2005) 193 CTR (AAR) 161. This is an early considered AAR treatment of derivative income earned by a foreign institutional investor, and it is useful for the sequence rather than the result. Characterisation comes first, and the Authority reasoned it from the nature of the instrument: an exchange-traded future or option has a life of about three months, carries no voting rights and involves no capital investment of the kind a share does, so a programme of trading in them is a business and not the realisation of investments. Placing the income in article 7 then made the permanent establishment question decisive, and the independent-agent finding on brokers and custodians did the rest. Both limbs need rechecking today - section 2(14) has since spoken directly to securities held by FIIs, and the India-UK agreement has moved on. If it applies to you, the first step is this: Characterise the instrument before you characterise the income; the exclusion of derivative contracts from the definition of capital asset is where the argument starts.
Morgan Stanley and Co. International Limited was incorporated in and a tax resident of the United Kingdom, and was registered with the Securities and Exchange Board of India as a Foreign Institutional Investor. It already traded in exchange-traded derivative instruments in India and proposed to expand that business. The instruments were index and stock futures and options, traded on Indian exchanges through brokers, with custodians and bankers acting as independent service providers. The contracts had a life of roughly three months, carried no voting rights and required no initial capital investment of the kind an equity holding does, and the annual volume of transactions was substantial, of the order of Rs 3,932 crores. A single question was put: whether the income derived by the applicant, a company incorporated in and tax resident of the United Kingdom, from trading in exchange traded derivative instruments in India would be taxable in India having regard to the provisions of the double taxation avoidance agreement between India and the United Kingdom. The matter was decided on 2004-11-29 by the Advance Ruling (Syed Shah Mohammed Quadri, J. (Chairman) and K. D. Singh, Member). On those facts the Advance Ruling held as follows. The Authority ruled that the income would not be taxable in India. It reached that in stages. Income from transactions of trading in derivatives is business income and not capital gains, derivative contracts being excluded from the definition of a capital asset, so the receipts fell to be dealt with under the business profits article and not under the capital gains article. Business profits of a UK enterprise are taxable in India only if earned through a permanent establishment situated here. The brokers, custodians and bankers through whom the applicant operated were agents of an independent status, acting for many clients in the ordinary course of their own businesses, and an enterprise is not deemed to have a permanent establishment merely because it carries on business through such agents. No permanent establishment therefore existed under article 5 of the India-UK agreement, and the income derived by the applicant from trading in exchange traded derivative instruments in India would not be taxable in India.
The Authority worked from the instrument outwards. An exchange-traded future or option is not a holding in a company: it confers no voting rights, requires no subscription of capital, and expires within months. Reading the definition of capital asset with the related definitions in section 2, it concluded that derivative contracts do not answer that description, so a surplus on closing them out cannot be a capital gain. What remained was a systematic, high-volume programme of buying and selling for profit, which is trade. That characterisation was the pivot of the ruling, because the India-UK agreement treats capital gains and business profits quite differently: capital gains would have been open to taxation in India, whereas business profits are reserved to the residence State unless attributable to a permanent establishment in the source State. The Authority then applied the ordinary agency test. The applicant had no fixed place of business in India, and its presence in the market was entirely through brokers who executed its orders, custodians who held its securities and bankers who moved its money. Each of those was carrying on its own business, for a general clientele, and none acted exclusively for the applicant or bound it to contracts. Paragraph 5 of article 5 protects an enterprise operating through such agents, and the Authority held it applied. With the income in article 7 and no permanent establishment, India had no taxing right. In the words reproduced by the source cited on this page: "The income derived by the applicant from trading in exchange traded derivative instruments in India would not be taxable in India."
It was decided by the Advance Ruling on 2004-11-29 and is reported as [2005] 272 ITR 416 (AAR); (2005) 193 CTR (AAR) 161. Binding only on the applicant who sought it, in respect of the transaction the ruling was sought on, and on the Principal Commissioner or Commissioner and the authorities subordinate to him in respect of that applicant and that transaction — and only until the law or the facts change (section 245S). It binds nobody else. The Tribunal and the courts nonetheless treat a considered ruling as persuasive, which is why practitioners cite them. An advance ruling binds only the applicant who sought it, only for the transaction it was sought on, and only the Commissioner and the officers under him in relation to that applicant and that transaction — and only until the law or the facts change. That is section 245S, and it means the ruling is not a precedent and binds nothing in your case. You cite it because the Authority reasoned the point out, often first and most fully, and the Tribunal and the courts treat a considered ruling as persuasive. Check before you rely on one: most of these were pronounced before 2009, and a great deal of cross-border tax has been rewritten since by amendment, protocol and judgment. On section 2(14), section 45, section 28, section 90, section DTAA art 7, section DTAA art 5, section DTAA art 14, the practical question is whether the facts of your own notice match the facts of this case closely enough for the same rule to apply.
It helps the taxpayer. The Authority ruled that the income would not be taxable in India. It reached that in stages. Income from transactions of trading in derivatives is business income and not capital gains, derivative contracts being excluded from the definition of a capital asset, so the receipts fell to be dealt with under the business profits article and not under the capital gains article. Business profits of a UK enterprise are taxable in India only if earned through a permanent establishment situated here. The brokers, custodians and bankers through whom the applicant operated were agents of an independent status, acting for many clients in the ordinary course of their own businesses, and an enterprise is not deemed to have a permanent establishment merely because it carries on business through such agents. No permanent establishment therefore existed under article 5 of the India-UK agreement, and the income derived by the applicant from trading in exchange traded derivative instruments in India would not be taxable in India. It arises in Capital Gains and Residence & Treaty Benefit matters, on section 2(14), section 45, section 28, section 90, section DTAA art 7, section DTAA art 5, section DTAA art 14 of the Income Tax Act 1961, and was decided by Syed Shah Mohammed Quadri, J. (Chairman) and K. D. Singh, Member. Before relying on it, read the source linked on this page and check whether it has since been distinguished, overruled or overtaken by an amendment to the Income Tax Act. In practice the steps that follow from it are these. Establish that brokers, custodians and bankers act for many clients in their own ordinary course of business, and keep the evidence. For an FII or FPI, read section 2(14) and section 115AD as they stand for your year before carrying this reasoning across. Cite it as persuasive only; under section 245S an advance ruling binds nobody but its own applicant.
Superseded by amendment. The characterisation limb no longer holds for a Foreign Institutional Investor. Section 2(14) as published at incometaxindia.gov.in now expressly includes in the definition of capital asset any securities held by a Foreign Institutional Investor which has invested in such securities in accordance with the SEBI regulations, so the business-income analysis on which this ruling turned cannot be carried across to an FII or FPI, and section 115AD supplies the charge. The independent-agent finding under article 5 is untouched by that amendment. No High Court or Supreme Court decision dealing with this ruling was found on Indian Kanoon. The Authority itself was replaced by the Board for Advance Rulings from 1 September 2021 (Finance Act 2021; Notification 96/2021), whose rulings are appealable to the High Court under section 245W, and the Income-tax Act 1961 was replaced by the Income-tax Act 2025 from 1 April 2026. No source could be cited for that finding. Checking whether an authority still stands matters as much as knowing what it held: a decision may be overruled on one point and survive on another, or the provision it interprets may have been amended since. Read the source and the editor's note on this page before relying on it in a reply to an Assessing Officer or in an appeal.
The claim in the note we were given that this is the 'first' considered AAR treatment of derivative income for foreign institutional investors was not verified and is not asserted here. Whether the statutory definition of a capital asset now reaches exchange-traded derivatives held by an FII, given how section 2(14) is worded, was not settled from the sources reached. The footnote identifying the amending Finance Act could not be read reliably from the departmental site. The reported citations come from the Indian Kanoon text. This library shows the verification state of every entry openly. This entry has not yet been read in full by a chartered accountant. The summary reflects the sources listed on this page. Read the source before you rely on it in a reply to an Assessing Officer or in an appeal before the Commissioner (Appeals) or the Income Tax Appellate Tribunal.
The Authority ruled that the income would not be taxable in India. It reached that in stages. Income from transactions of trading in derivatives is business income and not capital gains, derivative contracts being excluded from the definition of a capital asset, so the receipts fell to be dealt with under the business profits article and not under the capital gains article. Business profits of a UK enterprise are taxable in India only if earned through a permanent establishment situated here. The brokers, custodians and bankers through whom the applicant operated were agents of an independent status, acting for many clients in the ordinary course of their own businesses, and an enterprise is not deemed to have a permanent establishment merely because it carries on business through such agents. No permanent establishment therefore existed under article 5 of the India-UK agreement, and the income derived by the applicant from trading in exchange traded derivative instruments in India would not be taxable in India.
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