How are right entitlement transfers taxed?

I am a non-resident Indian (NRI) currently residing in the United Arab Emirates (UAE). I hold shares of Mahindra Logistics Ltd, and it has just announced a rights issue. I don’t want to subscribe to the issue, but want to sell the rights entitlements to a fellow NRI. What are the tax implications of doing that?

The right to subscribe to financial assets (such as equity shares) is distinct from such assets themselves. The Hon’ble Supreme Court of India has held that the right to subscribe to additional securities on a rights basis arises only after the company announces the rights issue. Until such an announcement, this right, though inherent in the shareholding, remains inchoate and does not crystallise. Upon announcement, this ‘Right Entitlement’ (RE) becomes a separate and independent capital asset, transferable independently of the underlying shareholding. If not exercised or renounced before the issue closing date, REs lapse and are extinguished.

These REs are generally qualified as short-term capital assets, as the offer for rights issues is typically open for a limited period during which the REs can be renounced. REs for listed companies are credited to the demat accounts of eligible equity shareholders who may renounce either:

• On-market, via the stock exchange (which attracts Securities Transaction Tax (STT)), or

• Off-market, through a private transfer (which does not attract STT).

In both scenarios, any gain from the transfer of REs is taxable as short-term capital gain at the applicable slab rates, with the entire sale consideration becoming taxable, since the cost of acquisition is deemed to be nil as per Indian tax law.

From a cross-border tax perspective, since REs are distinct from equity shares, they fall under Article 13(5) of the India-UAE Double Taxation Avoidance Agreement (DTAA), which is the residuary clause that covers gains from the alienation of property not covered elsewhere in Article 13. Under this clause, such gains are taxable only in the country of residence, i.e., the UAE, and not in India. Consequently, capital gains from the sale of REs by a UAE tax resident are not taxable in India under the India-UAE DTAA.

To claim this benefit under the India-UAE DTAA, the following compliance is required: (a) obtain a valid Tax Residency Certificate (TRC) from UAE authorities; (b) submit Form 10F on the Indian income tax portal and (c) file an income tax return in India disclosing the capital gain and reporting it as exempt under Article 13(5).

Harshal Bhuta is a partner at P. R. Bhuta & Co. Chartered Accountants.