The flag of the British Indian Ocean Territory (BIOT) is similar to the flags of other British dependencies and colonies as it has the Union Flag in the upper hoist-side corner. The palm tree and crown are symbols of the Indian Ocean Territory. The origin or meaning of the wavy lines is unknown, and their existence is a break from the traditional practice of flags of British colonies or former colonies. It is understood that the flag, which was granted by Queen Elizabeth II on the 25th anniversary of the BIOT in 1990 is that of the Commissioner and has only semi-official status.
The BIOT flag is similar to the flag of British Columbia.
Given that it is impossible for civilians to visit the British Indian Ocean Territory, it is not clear whether the flag is actually used. However, a video was released by the Naval Support Facility on Diego Garcia. It shows a scene where the flag is being flown. The only settlements on the Islands are the Anglo-American naval and air facilities.
The flag does indeed fly at Diego Garcia, along with the American Flag. Both are lowered at the end of the duty day.
It appears that the flag is also used by the Commissioner of the British Indian Ocean Territory. The Commissioner is based at the Foreign and Commonwealth Office in London.
Other images 
The flag flying on Diego Garcia