CBDT Includes OTC Derivatives in Rule 21AK for Section 10(4E) Tax Exemption

Notification No. 126/2025, dated 28-07-2025

The Central Board of Direct Taxes (CBDT) has notified an amendment to Rule 21AK of the Income-tax Rules, 1962, to include over-the-counter (OTC) derivatives in the list of specified transactions eligible for tax exemption under Section 10(4E) of the Income-tax Act. This change has been introduced to align the Rules with the amendments made by the Finance Act, 2025, which expanded the scope of the tax exemption available to non-residents engaging in certain financial transactions with International Financial Services Centres (IFSCs).

Section 10(4E) of the Income-tax Act provides for a tax exemption on income earned by non-residents from the transfer of specified derivative contracts entered into with offshore banking units located within an IFSC. The Finance Act, 2025, has further broadened the scope of this exemption to cover contracts entered into not only with offshore banking units but also with Foreign Portfolio Investors (FPIs) operating within IFSCs. This change reflects the government’s ongoing efforts to promote IFSCs as a global financial hub by offering a more favourable tax regime to international investors.

In line with these legislative changes, the recent amendment to Rule 21AK ensures that income earned by non-residents from over-the-counter (OTC) derivatives, transacted with either offshore banking units or FPIs based in an IFSC, will qualify as a “specified transaction” eligible for exemption under Section 10(4E). OTC derivatives are non-exchange traded contracts, often customized to meet the needs of sophisticated investors, and their inclusion under the exempt category is expected to enhance flexibility and appeal for foreign investors in IFSCs.

To implement this change, the CBDT has formally updated the language of Rule 21AK by inserting references to “over-the-counter derivatives” and “Foreign Portfolio Investor, being an IFSC Unit.” This amendment ensures consistency between the statutory provisions and the implementing rules, providing clarity to taxpayers and stakeholders operating within or through the IFSC framework. The move is part of a broader regulatory push to position Indian IFSCs, such as GIFT City, as a globally competitive destination for cross-border financial transactions.