Saudi Arabia resident's capital gains from rights entitlement sale taxable only in Saudi Arabia under Article 13(6) India-Saudi DTAA

ITAT Mumbai held that rights entitlement from shares are distinct from underlying shares, following SC precedent. Capital gains from sale of rights entitlement by Saudi Arabia resident are taxable only in Saudi Arabia under Article 13(6) of India-Saudi Arabia DTAA, not in India. Addition for capital gains deleted. Issue regarding advance tax credit restored to AO for verification and proper adjustment after pending rectification application consideration.

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The primary legal questions considered in this appeal are as follows:

1. Whether the capital gains arising from the sale of rights entitlement ("RE") attached to shares of an Indian company are taxable in India under Article 13(4) or 13(5) of the India-Saudi Arabia Double Taxation Avoidance Agreement ("DTAA"), or whether such gains fall under Article 13(6) and are taxable only in the resident country, Saudi Arabia.

2. Whether the Assessing Officer ("AO") erred in granting short credit of advance tax paid by the assessee.

3. Whether the levy of interest under section 234C of the Income Tax Act, 1961 ("the Act") was justified.

4. Whether penalty proceedings initiated under section 270A of the Act were appropriate.

Issue 1: Taxability of Capital Gains on Sale of Rights Entitlement under Article 13 of India-Saudi Arabia DTAA

Legal Framework and Precedents: Article 13 of the India-Saudi Arabia DTAA governs the taxation of capital gains. It distinguishes between gains arising from alienation of various categories of property, including immovable property, movable property of permanent establishments, shares linked to immovable property, other shares, and any other property. Specifically, paragraphs 4 and 5 allow taxation in the source country of gains arising from alienation of shares, whereas paragraph 6 restricts taxation of gains from alienation of any other property to the resident country of the alienator.

The pivotal question is whether rights entitlement should be treated as "shares" under Article 13(4) or (5), or as a distinct property under Article 13(6).

The coordinate bench of the Tribunal in Vanguard Emerging Markets Stock Index Fund vs. ACIT analyzed this issue in detail, relying on statutory provisions, regulatory circulars, and judicial precedents.

Court's Interpretation and Reasoning: The Court examined Section 62 of the Companies Act, 2013, which defines the process of further issue of share capital by way of rights issue. The section clarifies that rights entitlement constitutes an offer to existing shareholders to subscribe to additional shares, which can be accepted or renounced in favor of others. This inherently distinguishes rights entitlement from shares themselves.

Further, regulatory pronouncements by SEBI and the National Stock Exchange (NSE) treat rights entitlement as a separate security with a distinct International Securities Identification Number (ISIN), enabling trading and attracting Securities Transaction Tax (STT) at different rates compared to shares. This regulatory treatment underscores the separateness of rights entitlement from shares.

Additionally, the Securities Contracts (Regulation) Act, 1956 defines "option in securities" to include rights to buy or sell securities in the future, which aligns with the nature of rights entitlement as an option rather than a share.

The Court also relied on the Supreme Court's decision in Navin Jindal v. ACIT, which held that the right to subscribe to additional shares on a rights basis is a distinct, independent, and transferable right separate from the shares themselves. This precedent decisively supports the view that rights entitlement is not the same as shares.

Under the Income Tax Act, specific provisions such as sections 2(42A) and 55(2)(aa) treat rights entitlement distinctly from shares, further reinforcing the distinction.

Key Evidence and Findings: The Court noted the following:

• Rights entitlement is credited to demat accounts separately with unique ISINs.
• Rights entitlement can be traded independently of shares and is subject to a different STT regime.
• Statutory and regulatory frameworks treat rights entitlement as a separate security or option.
• Judicial precedent clearly establishes rights entitlement as a distinct right, transferable independently of shares.

Application of Law to Facts: The assessee, a Saudi Arabian resident, earned short-term capital gains from the sale of rights entitlement attached to shares of an Indian company. Since rights entitlement is distinct from shares, gains arising from their alienation fall under Article 13(6) of the DTAA, which provides taxing rights exclusively to the resident country of the alienator (Saudi Arabia).

Treatment of Competing Arguments: The Revenue argued that rights entitlement is inextricably linked to shares and therefore akin to shares, making gains taxable in India under Article 13(4) or (5). However, the Court found this linkage insufficient to treat rights entitlement as shares, especially in light of the statutory, regulatory, and judicial authorities distinguishing the two.

Conclusion: The Court held that rights entitlement is distinct from shares and that capital gains arising from their sale are taxable only in Saudi Arabia under Article 13(6) of the India-Saudi Arabia DTAA. Consequently, the addition of such gains to the assessee's income in India was deleted.

Issue 2: Short Credit of Advance Tax Paid

Legal Framework: The assessee claimed credit for advance tax paid, which the AO allegedly short credited.

Court's Reasoning: The assessee had filed a rectification application regarding this issue, which was pending. The Court found it appropriate to restore this issue to the AO for fresh consideration after necessary verification.

Conclusion: The matter was remanded for appropriate credit of advance tax paid, and the ground was allowed for statistical purposes.

Issue 3: Levy of Interest under Section 234C of the Act

Legal Framework: Section 234C imposes interest for deferment of advance tax installments.

Court's Reasoning: Since the interest is consequential to the tax computation, the Court found no need for separate adjudication on this ground.

Conclusion: No separate relief was granted on this ground.

Issue 4: Initiation of Penalty Proceedings under Section 270A of the Act

Legal Framework: Section 270A deals with penalty for under-reporting or misreporting of income.

Court's Reasoning: The Court deemed the initiation of penalty proceedings premature at this stage.

Conclusion: The ground was dismissed.

Significant Holdings:

The Court's crucial legal reasoning on the primary issue is encapsulated in the following observations:

"...the rights entitlement though embedded in the original shareholding is separate and distinct right capable of being transferred independently of the existing shareholding... therefore, the rights entitlement to the shares are distinct from the shares."

"...rights entitlement is credited to the demat account of the investor and it is an asset, which is different from shares of the company and therefore, a separate ISIN is given for rights entitlement."

"...the right to subscribe to additional shares/debentures on right basis... is a distinct, independent and separate right, capable of being transferred independently of the existing shareholding..."

These principles establish that rights entitlement is a separate security or option, not shares, and thus gains from their alienation are taxable only in the alienator's resident country under Article 13(6) of the DTAA.

Final determinations include:

• Capital gains on sale of rights entitlement are not taxable in India but only in Saudi Arabia under Article 13(6) of the India-Saudi Arabia DTAA.
• Advance tax credit issue remanded to AO for verification and appropriate credit.
• Interest under section 234C requires no separate adjudication.
• Penalty proceedings under section 270A are premature and dismissed.

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