Rights entitlement gains qualify for India-Ireland DTAA exemption under Article 13(6), tribunal allows beneficial set-off of capital gains/losses

ITAT Mumbai held that rights entitlement gains qualify for exemption under Article 13(6) of India-Ireland DTAA, not Article 13(5), as rights entitlement differs from shares. The tribunal deleted the addition made by AO denying this exemption. Regarding set-off of short-term capital gains/losses, ITAT ruled that no prohibition exists preventing set-off of STCG from non-STT paid shares against STCL from STT paid shares, allowing assessee to choose beneficial set-off chronology. AO was directed to delete related additions and consider assessee's rectification petitions regarding TDS credit and refund claims in accordance with law.

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1. ISSUES PRESENTED and CONSIDERED

The core legal questions considered in these appeals arising under the Income Tax Act, 1961 and the India-Ireland Double Taxation Avoidance Agreement (DTAA) for AY 2022-23 are:

• Whether short-term capital gains (STCG) arising from the sale of rights entitlement (RE) of shares of an Indian company are taxable in India or exempt under Article 13(6) of the India-Ireland DTAA.
• Whether rights entitlement can be treated as shares under Article 13(5) of the India-Ireland DTAA, thereby attracting source-based taxation in India.
• The permissibility and manner of set-off of STCG arising from non-Securities Transaction Tax (STT) paid shares against short-term capital loss (STCL) arising from STT paid shares, given the differential tax rates applicable under the Act.
• Issues relating to short credit of Tax Deducted at Source (TDS), levy of interest under sections 234A to 234B of the Act, levy of penalty, and short grant of refund including non-consideration of rectification applications.
• Legal validity of notices issued under section 143(2) by the National Faceless Assessment Centre (NFAC) instead of the jurisdictional Assessing Officer (AO).

2. ISSUE-WISE DETAILED ANALYSIS

Issue 1: Taxability of Short-Term Capital Gains on Sale of Rights Entitlement

Relevant Legal Framework and Precedents: The India-Ireland DTAA's Article 13 governs taxation of capital gains. Article 13(5) taxes gains from alienation of shares in a company resident in the source state, while Article 13(6) provides that gains from alienation of any property other than those mentioned in paragraphs 1 to 5 are taxable only in the resident state. Section 62 of the Companies Act, 2013 deals with rights issue and rights entitlement. The Securities and Exchange Board of India (SEBI) and National Stock Exchange (NSE) have issued circulars recognizing rights entitlements as distinct dematerialized securities with separate International Securities Identification Numbers (ISINs). The Supreme Court judgment in Navin Jindal v. ACIT established that rights entitlement is a distinct, independent, and transferable right separate from shares.

Court's Interpretation and Reasoning: The Court examined whether rights entitlement should be treated as shares under Article 13(5) or as a separate property under Article 13(6). It was noted that rights entitlement confer a right to subscribe to shares but are not shares themselves. The Companies Act explicitly distinguishes between shares and rights to subscribe to shares, allowing renunciation or transfer of such rights. SEBI and NSE treat rights entitlement as distinct securities with separate ISINs and subject to STT as options in securities, not as shares. The Supreme Court's ruling reinforced that rights entitlement is a separate asset distinct from shares. The Court further analyzed the OECD and UN Model Tax Conventions and the amendments introduced by the Multilateral Instrument (MLI) to the India-Ireland DTAA, noting that "comparable interests" were included only in Article 13(4) and not in Article 13(5), indicating a narrow scope for "shares" under Article 13(5).

The Court also considered clarifications from the Government of India, which distinguished between shares and derivatives or other securities for taxation purposes under DTAA amendments. Applying Section 90(3) of the Act and Article 3(2) of the DTAA, the Court held that undefined terms in the treaty should be interpreted as per domestic law, which defines shares restrictively. Analogizing rights entitlement to derivatives, the Court concluded that rights entitlement falls outside the scope of "shares" under Article 13(5) and is covered under Article 13(6), making gains taxable only in the resident state, Ireland.

Key Evidence and Findings: The Court relied on statutory provisions (Companies Act, SEBI and NSE circulars), judicial precedent (Navin Jindal), international model conventions, treaty amendments, and government clarifications. The distinct treatment of rights entitlement as an option or separate security, and the absence of "comparable interests" in Article 13(5) post-MLI amendment, were critical findings.

Application of Law to Facts: The assessee, being a resident of Ireland, earned STCG from sale of rights entitlement of shares of an Indian company. The AO taxed this gain under Article 13(5), treating rights entitlement as shares. The Court rejected this view, applying the above analysis to hold that rights entitlement gains are exempt from Indian tax under Article 13(6) and taxable only in Ireland.

Treatment of Competing Arguments: The Revenue argued that rights entitlement are closely related to shares and should be taxed under Article 13(5). The Court considered and rejected this, emphasizing statutory and regulatory distinctions and authoritative judicial pronouncements. The Revenue's reliance on the DRP's observations was rebutted point-wise by the assessee, with the Court siding with the assessee's interpretation.

Conclusion: Rights entitlement is a distinct asset from shares and gains arising from its alienation are exempt from Indian tax under Article 13(6) of the India-Ireland DTAA.

Issue 2: Set-Off of Short-Term Capital Gains and Losses Arising from STT and Non-STT Paid Shares

Relevant Legal Framework and Precedents: Section 70 of the Income Tax Act permits set-off of losses against income computed under the same head. The Act provides different tax rates for STCG arising from shares on which STT is paid (15%) and those on which STT is not paid (30%). The Hon'ble Calcutta High Court in a 2008 decision held that there is no statutory prohibition on set-off of STCL arising from STT paid shares against STCG arising from non-STT paid shares. The Tribunal in several coordinate bench decisions (including J.P. Morgan India Investment Company Mauritius Ltd. and others) has followed this principle.

Court's Interpretation and Reasoning: The Court observed that the AO's denial of set-off was based on a misinterpretation of section 70, incorrectly requiring "similar computation" for set-off. The Court held that the Act does not prescribe any specific order or restriction on the set-off of capital gains and losses arising from STT and non-STT paid shares. The assessee is entitled to choose the order of set-off most beneficial to it. The Court relied on the Calcutta High Court's ruling and subsequent Tribunal decisions affirming this principle.

Key Evidence and Findings: The Court examined the factual computation of STCG and STCL by the assessee, the AO's rejection, and the judicial precedents supporting the assessee's position.

Application of Law to Facts: The assessee had set off STCG arising from non-STT paid shares against STCL arising from STT paid shares. The AO disallowed this set-off. Applying the legal principles, the Court directed the AO to accept the assessee's computation and allow the set-off.

Treatment of Competing Arguments: The Revenue contended that different tax rates and STT applicability preclude such set-off. The Court rejected this, emphasizing the absence of any statutory prohibition and the beneficial option available to the assessee.

Conclusion: The set-off of STCG from non-STT paid shares against STCL from STT paid shares is permissible under the Act, and the AO's disallowance is unsustainable.

Issue 3: Other Ancillary Issues

The assessee raised grounds regarding short credit of TDS, levy of interest under sections 234A to 234B, levy of penalty, and short grant of refund including non-consideration of rectification applications. The Court directed the AO to consider rectification petitions and claims in accordance with law, granting the assessee reasonable opportunity of hearing. The legal ground relating to issuance of notice by NFAC was held to be academic in light of the merits decision and left open.

3. SIGNIFICANT HOLDINGS

"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."

"Section 62 of the Companies Act, 2013 provides that 'unless the articles of the company otherwise provide, the offer aforesaid shall be deemed to include a right exercisable by the person concerned to renounce the shares offered to him or any of them in favour of any other person.' It is evident that a shareholder obtains an exercisable right to subscribe to shares which is different from shares in the Indian company."

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

"There is no prohibition nor the Act compels the assessee to first set off short term capital gain with STT against short term capital loss with STT and then allows set off against short term capital gain without STT. In absence of any specific mode of set off provided in the Act and in absence of any prohibition and in absence of any specific chronology for set off prescribed in the Act, the assessee was entitled to exercise his option with regard to the chronology of set off which was most beneficial to the assessee."

Final determinations:

• STCG arising from sale of rights entitlement is exempt from Indian tax under Article 13(6) of the India-Ireland DTAA and taxable only in Ireland.
• Rights entitlement is a distinct asset from shares and does not fall within the scope of Article 13(5) of the DTAA.
• Set-off of STCG from non-STT paid shares against STCL from STT paid shares is permissible and the AO's disallowance is set aside.
• Ancillary claims regarding TDS credit and refund are to be considered afresh by the AO in accordance with law.
• Legal issues relating to jurisdiction of notice issuance are left open as academic.

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