Can Foreign Investors Use F&O Losses to Reduce Tax on Dividend Income?

Introduction

Consider a non-resident investor who trades in futures and options (F&O) on Indian stock exchanges. Like most traders, such an investor may, from time to time, incur losses due to market volatility. At the same time, the investor may hold shares in Indian companies and earn dividend income, which is taxed at a special rate under Section 115A of the Income Tax Act,1961. A simple question arises: can losses incurred in F&O trading be used to reduce the tax payable on such dividend income? Although this may appear to be a simple accounting matter, it is in fact a complex legal question, situated in between two distinct statutory provisions, the interpretation of which can affect an investor's tax liability.

Taxation of Non-Resident Dividend Income under Section 115A

Section 115A of the Act taxes certain categories of income earned by non-residents, including dividend income, at a special rate of 20% (10% in the case of certain dividends linked to International Financial Services Centre (IFSC)). However, the same provision stipulates that no deduction may be claimed in respect of any "expenditure or allowance" while computing such income. In other words, dividend income under Section 115A is intended to be taxed on a gross basis, without any deduction for expenses.

Restriction applies only to allowances and expenditure.

It is important to appreciate that a "deduction for expenditure" and a "set-off of losses" are legally two separate concepts. A deduction for expenditure is claimed while computing income under a particular head. Whereas set-off of loss, is a separate and subsequent step, undertaken only after the income under each head has already been computed.

This distinction was fundamental to the reasoning of the Income Tax Appellate Tribunal in Hyosung Corporation v. ACIT (International Taxation), [2025] 174 taxmann.com 500 

(Delhi-Trib.). In this case, the Indian branch of a Korean company had incurred business losses while simultaneously earning income from Fees for Technical Services (FTS), which was taxable at special rate under section 115A of the Income Tax Act, 1961. The Assessing Officer (AO) declined to permit a set-off, relying on the "gross taxation" principle. The Tribunal disagreed with the AO’s decision.

The Tribunal rational that Section 115A begins with the words "Where the total income of…", which presupposes that total income has already been computed in accordance with the ordinary provisions of the Act, including the set-off of losses under Sections 70 and 71 of the Income-tax Act, 1961, respectively. It is only the specific income FTS that survives after such computation which is thereafter taxed at the special rate. The Tribunal further observed that where Parliament intends to restrict the set-off of losses, it does so explicitly, as it has done under Section 115BBDA(2) of the Income-tax Act, 1961 (a provision not carried forward into the 2025 Act) and under Section 115BBH of the Income Tax Act, 1961(corresponding to Section 194 of the Income-tax Act, 2025). Section 115A contains no such express bar, and this silence appears to be a deliberate legislative choice.

Support from earlier precedent

This is not an isolated view. In Hitachi Zosen Corporation v. Deputy Commissioner of Income-tax, [1999] 68 ITD 235 (Mumbai); [1999] 63 TTJ 391 (Mumbai), the Tribunal similarly held that the ordinary computation provisions of the 1961 Act must be given full effect, since the special rate provision contained no words excluding their application. Although decided decades apart, both rulings arrive at the same conclusion: special-rate taxation applies at the final stage of computation, not at the onset- total income must first be determined in accordance with the general provisions of the 1961 Act.

Separately, it is well established that F&O losses arising from transactions on recognised stock exchanges, where securities transaction tax (STT) has been paid, constitute non-speculative business losses rather than speculative losses, following the amendment made in 2006 to Section 43(5)(d) of the Income-tax Act, 1961.

Read in unison, these authorities support a reasonably strong position that a non-resident investor's F&O loss should be capable of being set off against dividend income before the special rate under Section 115A of the Act is applied, since Section 115A of the Act restricts only the deduction of expenditure, and not the set-off of losses, and because total income must first be computed as a whole under the general provisions of the Act.

A practical obstacle: the income tax return form

Even where the underlying legal position is sound, taxpayers face a practical difficulty arising from the income tax return filing utility itself. Schedule CYLA (Current Year Loss Adjustment) in Forms ITR-2, ITR-3 and ITR-4, which is the schedule intended to give effect to set-offs under Section 71 of the Income Tax Act, 1961, does not contain a field permitting a business loss to be set off against "Income from other sources" that is taxable at a special rate, such as dividend income under Section 115A of the Income Tax Act, 1961. The form appears to assume that all such income is taxed at normal rates.

Why this issue merits attention

This matter illustrates a broader and recurring difficulty in Indian tax law: provisions enacted at different points in time, for different purposes, occasionally interact in ways not anticipated by Parliament, and the administrative systems used to implement the law have not always kept pace. Special-rate regimes applicable to non-residents were designed to simplify tax collection. However, the mechanical application of that principle to investors who simultaneously hold loss-making derivative positions and profit-making equity shares may result in genuine unfairness if losses are disregarded, particularly where the filing system does not even permit the claim to be made.

Conclusion

While Section 115A reinforces taxation of dividend income without deduction for expenditure or allowance, this does not bar the set-off of business losses against such income, as the restriction is confined only to allowances and expenditure. However, at present, the ITR utility does not permit such set-off in practice, creating a genuine hardship for taxpayers whose legitimate claims are being denied due to a system-level limitation rather than any bar under the law. It is hoped that this anomaly will be suitably addressed in the upcoming ITR utility under the new Income Tax Act, 2025, enabling taxpayers to claim set-off of business losses against dividend income taxed under special rates in line with the correct legal position.