Transfer Of Rights Entitlement Is Not Akin To Transfer Of Shares

BACKGROUND

• The Asssessee¹ , was established in Saudi Arabia and is certified to be a tax resident in Saudi Arabia for the purposes of India-Saudi Arabia DTAA ('the Treaty').
• During AY 2022-23, the Assessee, inter alia, earned short-term capital gains amounting to INR 3.82 crores on sale of rights entitlement vis-à- vis the shares of an Indian company, Bharti Airtel Ltd. ('the Company') held by it. These capital gains were not offered for taxation by the Assessee, claiming that the rights entitlement are not shares and the capital gains arising therefrom are not taxable in India in view of provisions of Article 13(6)² of the Treaty.
• While claiming non-taxability of such capital gains in India, the Assessee submitted that rights entitlement is a right to buy additional shares in a company and is made to the company's existing shareholders, and the same is not shares per se. Thus, the rights entitlement is a security separate from that of shares and cannot be construed to be the same as shares.
• The Assessing Officer ('AO'), however, disagreed and contended that the value of rights is carved out of existing shares held by an entity and hence they should be treated as shares only. Accordingly, the AO included the capital gains earned by the Assessee on sale of rights entitlement in its total income and brought the same to tax in India in view of Article 13(4)/(5)2 of the treaty.
• DRP, while rejecting the objections filed by the Assessee, observed as under-
  1. Rights entitlement and shares are closely related assets.
  2. Shares represent ownership in a company, while rights entitlement offer rights to the existing shareholders to buy a certain number of new shares at a discounted price. 
  3. By exercising their rights entitlement, existing shareholders can subscribe to the new shares and increase their ownership in the company. 
  4. Rights entitlement is linked to shares on origin and also in the final conversion upon exercise of the subscription. 
  5. Therefore, rights entitlement and shares are financial instruments of the same class and hence word 'shares' in Article 13(4)/(5) of the treaty can be broadly interpreted to include similar or comparable interests. 
  6. Thus, rights entitlement are shares and intrinsically and inextricably linked to shares. Therefore, the transfer of rights entitlements would not fall under Article 13(6) of the treaty.
• Aggrieved by the order of DRP, the Assessee filed an appeal before the Tribunal.

TRIBUNAL'S OBSERVATIONS

• There is no dispute regarding the fact that the Assessee, being a resident of Saudi Arabia, earned short-term capital gains on the sale of rights entitlement vis-à-vis its shares of Bharti Airtel Ltd., which is an Indian company.
• In order to decide whether the present case falls within the ambit of Article 13(4)/(5) or Article 13(6) of the treaty, it is firstly pertinent to conclude whether the rights entitlement is akin to shares.
• Referred the co-ordinate bench ruling³ of the Tribunal wherein the Bench analyzed section 62 of the Companies Act, 2013 and deduced that rights entitlement are not equity shares as this section provides that a shareholder, in whose favour an offer to subscribe to shares is made, have the option to subscribe to additional shares or renounce/sell their rights entitlement to any other person. In any case, a shareholder obtains an exercisable right to subscribe to shares which is different from shares in the company.
• While dealing with the issue of the rights entitlement, the co-ordinate bench also referred to SEBI and NSE circulars⁴ wherein rights entitlement has been treated differently from shares in terms of credit of rights entitlement in a demat account with a distinct ISIN (International Securities Identification Number) and charge of securities transaction tax on their trading at a rate different from equity shares.
• The co-ordinate bench further resorted to provisions of section 2(42A) and section 55(2)(aa) of the Income-tax Act, 1961 which, inter-alia, deals with holding period and cost of acquisition respectively of a right to subscribe to any financial asset which is renounced in favour of any other person, to corroborate the fact that right to subscribe to any financial asset is distinct from shares.
• Remarked that DRP, though correctly noted that the existing shareholder of the company can subscribe to the new shares 'only by exercising' their rights entitlement, lost sight of this significant aspect and arrived at an incorrect conclusion.
• Placed reliance on the judgement⁵ of Hon'ble Supreme Court, wherein the Apex Court held that the right to subscribe to additional offer of shares on right basis on the strength of existing shareholding in a company comes into existence only when the company decides to come out with right offer. The same crystallizes only when the rights offer is announced by the company. The said right to subscribe to additional shares, though embedded in the original shareholding, is a distinct, independent and separate right, capable of being transferred independently of the existing shareholding, on the strength of which such rights are offered.
• Concurred with the contentions of the Assessee that rights entitlement is inextricably linked to shares held by the Assessee in the Company, but the same is not shares. 
• Allowed the appeal by holding that short-term capital gains from sale of rights entitlement, is only taxable in the resident state, i.e., Saudi Arabia as per Article 13(6) of the treaty.

AURTUS COMMENTS

• This decision, by distinguishing rights entitlement from shares, has reinforced the principle of interpretation of treaty provisions which should be based on their specific wordings rather than any other wider connotations.
• Therefore, Investors should carefully evaluate the classification of an instrument under a Treaty before determining its taxability in India in light of the provisions of the Act and the Treaty.

Footnotes

1. General Organization for Social Insurance [TS-636-ITAT-2025(Mum)]

2. Article 13 (4)/(5) of the treaty give right to India to tax capital gains on alienation of shares of an Indian company. On the other hand, Article 13(6) of the treaty provides that gains arising from alienation of property other than referred to in Article 13(1) to Article 13(5) shall be taxable only in the country of which alienator is a resident i.e., Saudi Arabia.

3. Vanguard Emerging Markets Stock Index Fund v. ACIT [2025] 172 taxmann.com 515 (Mumbai-Trib.)

4. SEBI Circular dated 22/01/2020 on 'Streamlining the Process of Rights Issue' NSE Circular dated 19/02/2020

5. Navin Jindal v. Assistant Commissioner of Income-tax 187 Taxman 283/320 ITR 708 (SC)

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