By Annie Banerji

NEW DELHI (Reuters) - Two Italian sailors charged with killing two Indian fishermen lost on Friday their Supreme Court bid to be tried on home soil, a victory for India in a diplomatic tussle over jurisdiction that has strained ties between the countries.

The sailors, members of a military security team protecting a cargo ship, Enrica Lexie, say they mistook the fishermen for pirates off the southern Indian state of Kerala in February 2012.

The Supreme Court ruled that a special court should be set up to try the marines, lawyers who attended the hearing told reporters afterwards. There were no immediate details about how the court arrived at its long-awaited decision.

Italy challenged India's right to try the sailors in the New Delhi Supreme Court, saying the shooting took place in international waters, outside the jurisdiction of Indian courts.

Indian authorities accuse the sailors of shooting unarmed fishermen in a "contiguous zone" where Indian law applies.

The incident has caused a serious diplomatic dispute between Italy and India, which have traditionally had good relations.

The verdict comes almost a month after Italy expressed "strong disappointment" that the Supreme Court had delayed the decision on where the two men would face trial.

Sailors Massimiliano Latorre and Salvatore Girone spent Christmas in Italy after a Kerala court allowed them to join their families for the holiday on condition that they returned to India by January 10, which they did.

In April, Italy paid $190,000 compensation to each of the victims' families, who then dropped their cases against the marines.

In October, Ferrari's Formula One team emblazoned its cars with the Italian navy's flag in the Indian Grand Prix in a show of solidarity with the military officers, reigniting Indian anger over the incident.

Attacks on ships have increased in the eastern side of the Arabian Sea, as better security around the Horn of Africa has pushed Somali pirates to range as far as the Maldives. The waters close to India are generally considered safer.

(Reporting by Suchitra Mohanty and Annie Banerji; Editing by Ross Colvin and Robert Birsel)