2025 (3) TMI 932 - AT - Income Tax

Rights entitlement from shares constitutes distinct asset separate from underlying shares under India-Ireland DTAA Article 13(6)

Vanguard Emerging Markets Stock Index Fund A Series of VISPLC C/o. Ernst & Young LLP Versus Assistant Commissioner of Income Tax (International Tax) – 4 (3) (1), Mumbai

ITAT Mumbai held that rights entitlement from shares constitutes a distinct asset separate from underlying shares, similar to derivatives. Under ... Taxation of short term capital gain on sale of 'rights entitlement' falling within the purview of Article 13(5) of DTAA between India and Ireland (Treaty) - whether capital gain earned from sale of 'rights entitlement' can be claimed as exempt u/Article 13(6) of India-Ireland DTAA which provides that gains from transfer/alienation of any property other than those mentioned in Articles 13(1) to 13(5) shall be taxable only in Ireland? - HELD THAT:- We find that the definition of shares even in Section 2(84) of the Companies Act, 2013 provides a restrictive definition of shares to mean a share in the share capital of a company and includes stock. Otherwise also an asset, which may come into existence or derive its value from another underlying asset, cannot be regarded as being same as the original asset. An analogy may be drawn to a 'derivative', which may derive its value from the underlying equity but it is a well-established principle that the derivative contract is a distinct and separate asset. Under the India-Ireland DTAA a derivative deriving its value from underlying equity would not be subject to tax in India u/Article 13(6). Likewise rights entitlement which is granted on account of shareholding cannot be regarded as being the same as shares especially since the rights shares are allotted, only on subscription. The rights entitlement, being a distinct asset, may be sold lapsed or subscribed and thus, akin to derivatives, ought to be not subject to tax under Article 13(6) of the India-Ireland DTAA. Similarly, the investor can either sell the rights entitlement option or exercise the option to get shares or decline the offer for shares. Hence, in our opinion, rights entitlement would also be covered under the provisions of Article 13(6) of India Ireland DTAA and in that case it would not be subjected to tax in India but it shall be taxable in the resident state i.e. Ireland. As per explanation given by the ld. Counsel and the view taken by the ld. DRP to hold that rights entitlement shares and the shares are closely related assets; we are in agreement with the contention raised by the ld. Counsel that these are separate assets and it distinct of the shares of the Indian Government. Accordingly, we hold that rights entitlements is not covered under Article 13(4) and Article 13(5) so as to be taxed in the country of source i.e. in India, albeit, it falls under Article 13(6) whereby, gain on alienation of any property which are not covered in para 1 to 5 is taxable only in the resident state i.e. Ireland. Adjustment of short term capital gain arising on sale of rights entitlement from which the assessee had claimed benefit of Article 13(6) of India Ireland DTAA against the short term capital loss arising on sale of shares which is taxable in India in terms of Article 13(5) of the DTAA - Accordingly, we hold that the capital loss incurred under the provisions of the Act r.w. Article 13(5) of India-Ireland DTAA cannot be set off against short term capital gain derived from sale of rights of entitlement because such case is not subjected to tax in India as per Article 13(6) of DTAA and therefore, assessee has rightly excluded from the computation of total income, accordingly, this issue is decided in favour of the assessee. ISSUES PRESENTED and CONSIDEREDThe primary issue considered in this judgment is whether the short-term capital gains earned by the assessee from the sale of 'rights entitlement' should be taxed in India under Article 13(5) of the India-Ireland Double Taxation Avoidance Agreement (DTAA) or be exempt under Article 13(6), thereby being taxable only in Ireland.ISSUE-WISE DETAILED ANALYSISThe core legal question revolves around the interpretation of Articles 13(5) and 13(6) of the India-Ireland DTAA concerning the taxation of gains from the sale of rights entitlements. The Tribunal examined whether these rights entitlements are akin to shares and thus taxable in India or if they should be treated as distinct assets taxable only in Ireland.Relevant legal framework and precedents:Article 13 of the India-Ireland DTAA outlines the taxation of capital gains. Article 13(5) allows taxation in India for gains from the alienation of shares in an Indian company. Article 13(6) provides that gains from the alienation of any property not covered in the preceding paragraphs are taxable only in the resident state.Relevant precedents include the Supreme Court's decision in Navin Jindal v. Assistant Commissioner of Income Tax, which distinguished rights entitlements from shares, and the Tribunal's decision in J.P. Morgan India Investment Company Mauritius Ltd., which addressed the issue of setting off capital gains against losses under treaty benefits.Court's interpretation and reasoning:The Tribunal reasoned that rights entitlements are distinct from shares, as they represent an exercisable right to subscribe to shares rather than the shares themselves. The Tribunal relied on the Supreme Court's interpretation that such rights are separate and independent from the existing shareholding.The Tribunal also noted that the India-Ireland DTAA, even after amendments post-MLI, does not include 'comparable interests' in Article 13(5), indicating that rights entitlements do not fall within its ambit.Key evidence and findings:The Tribunal considered the provisions of the Companies Act, 2013, SEBI Circulars, and the OECD and UN Model Tax Conventions. These documents collectively supported the view that rights entitlements are distinct from shares, as evidenced by separate ISINs and different tax treatments under the Securities Transaction Tax (STT).Application of law to facts:The Tribunal applied the distinction between rights entitlements and shares, as established in legal precedents and supported by regulatory frameworks, to conclude that gains from rights entitlements fall under Article 13(6) of the DTAA and are taxable only in Ireland.Treatment of competing arguments:The Tribunal addressed the Revenue's argument that rights entitlements are akin to shares and should be taxed in India. It rebutted this by highlighting the legal and regulatory distinctions between the two, as well as the absence of 'comparable interests' in Article 13(5) of the DTAA.Conclusions:The Tribunal concluded that the gains from the sale of rights entitlements are not taxable in India under Article 13(5) but are instead taxable only in Ireland under Article 13(6) of the DTAA.SIGNIFICANT HOLDINGSThe Tribunal held that rights entitlements are distinct from shares and thus fall under Article 13(6) of the India-Ireland DTAA. The gains from their sale are taxable only in Ireland, not in India.The Tribunal quoted the Supreme Court's reasoning in Navin Jindal, emphasizing the distinct nature of rights entitlements from shares.The Tribunal also upheld the principle that, when a taxpayer claims treaty benefits, the income is computed under the treaty provisions, and the source country gives up its taxing rights, as established in J.P. Morgan India Investment Company Mauritius Ltd.The Tribunal directed the Assessing Officer to rectify the computation error regarding the refund amount as per the assessee's application under Section 154.Other grounds challenging the assessment's validity were dismissed as infructuous, and the appeal was allowed on merits.