VANGUARD EMERGING MARKETS STOCK INDEX FUND A SERIES OF VISPLC,MUMBAI vs. ACIT (INTERNATIONAL TAX)-4(3)(1), MUMBAI

However, the ld. DRP held that rights entitlement (RE) and shares (equity) are closely related assets. In sum and substance, the directions and the observations / finding of the ld. DRP can be summarized in the following manner:-  Rights entitlement are a discount on equity shares;  Shares represent ownership in the company whilst right entitlements are the rights given to existing shareholders to buy new shares in a right issue. By exercising their right entitlements, shareholders can subscribe to the new shares and increase their ownership in the company.  Right entitlement are like bonus for existing shareholders;  The assessee has the option to buy the equity shares at a discounted price or sell the rights entitlement:

Gains derived by a resident of a Contracting State from the alienation of immovable property referred to in Article 6 and situated in the offer Contracting State may also be taxed in that other State 2. Gains from the alienation of movable property forming part of the business property of a permanent establishment which an enterprise of a Contracting State has in the other Contracting State or of movable property pertaining to a fixed base available to a resident of a Contracting State in the other Contracting State for the purpose of performing independent personal services, including such gains from the alienation of such permanent establishment (alone or with the whole enterprise) or of such fired base, may also be taxed in that other State.

Para 5 of Article 13 provides that taxability of gains from alienation of shares in a company which is resident of that contracting state may be taxed in that contracting state. For example, if a resident of Ireland State sells shares of a Company in India then it may be taxed in India, that is, the source state. Article 13(6) on the contrary is applicable to the gains from the alienation of any property other than those referred to in para 1 to para 5 of the Article 13, which is taxable only in the resident state. The issue before is, whether rights entitlement is akin to shares and whether shares and rights entitlements are exactly similar assets? And if they are not in nature of shares then whether can it be taxed in source state, that is, India. It has been argued before us on behalf of the assessee that there is a distinction between shares and rights entitlement under the companies and SEBI law.

First of all, our attention was drawn to Section 62 of the Companies Act, 2013 which for the sake of ready reference is reproduced hereunder:- “62. Further issue of share capital (1) Where at any time, a company having a share capital proposes to increase its subscribed capital by the issue of further shares such shares Vanguard Emerging Markets Stock Index Fund A Series of VISPLC shall be offered 1. (a) to persons who, at the date of the offer, are holders of equity shares of the company in proportion. as nearly as circumstances admit, to the paid-up share capital on those shares by sending a letter of offer subject to the following conditions, namely (1) the offer shall be made by notice specifying the number of shares offered and limiting a time not being less than fifteen days 1 for such lesser number of days as may be prescribed) and not exceeding thirty days from the date of the offer within which the offer if not accepted shall be deemed to have been declined, (ii) 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 favours of any other person, and the notice referred to in clause (1) shall contain a statement of this right; (ii) after the expiry of the time specified in the notice aforesaid or on receipt of earlier intimation from the person to whom such notice is given that he declines to accept the shares offered, the Board of Directors may dispose of them in such manner which is not disadvantageous to the shareholders and the company.”

From the perusal of the aforesaid provisions, it could be deduced that “rights entitlement” are not equity shares because the Section provides shareholder in whose favour an "offer" to subscribe to shares is made, may either accept the offer or exercise the right to renounce the offer or transfer the right to any other person. Ergo, a shareholder obtains an exercisable right to subscribe to shares which is different from shares in the Indian Company.

SEBI has issued a Circular dated 22/01/2020 on “Streamlining the Process of Rights Issue (SEBI Circular). Relevant extract of the SEBI Circular is reproduced below:- "Introduction of dematerialized Rights Entitlements (REs) - Vanguard Emerging Markets Stock Index Fund A Series of VISPLC 1.3.2. REs shall be credited to the demat account of eligible shareholders in dermaterialized form. 1.3.3. in REs process, the REs with a separate ISIN shall be credited to the demat account of the shareholders before the date of opening of the issue, against the shares held by them as on the record date.”

Thus, what can be inferred is that, RE 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. Even the National Stock Exchange of India Limited (NSE) had issued a similar Circular dated 19/02/2020 according to which trading in dematerialized rights entitlements on the stock exchanges shall be chargeable to Securities Transaction Tax (STT) at the rate specified in Finance (No.2) Act, 2004, in respect of "Sale of an option in securities (i.e. payable by the seller at the rate of 0.05% of the value at which such rights entitlements are traded). Thus, rights entitlements have been treated differently from shares by the SEBI and NSE.

It has been further brought to our notice that as per the Finance Act, 2004 “option in securities” has been defined to have the same meaning assigned to it in clause (d) of section 2 of the Securities Contracts (Regulation) Act. 1956 (SCRA). Clause (d) of section 2 of the SCRA defines "option in securities to mean purchase or sale of a right to buy or sell, or a right to buy and sell, securities in future, and includes a teji, a mandi, a taji mandi, a galli, a put, a call or a put and call in securities. Accordingly, it has been submitted that rights entitlement is an option to Vanguard Emerging Markets Stock Index Fund A Series of VISPLC purchase a security (which could be shares of an Indian company) in the future. Further, the prescribed rate of STT on purchase of equity shares is different, which clearly evidences that rights, entitlement is not the same as shares.

In support of the contention that rights entitlement are different from the shares, Ld. Counsel for the assessee had strongly placed reliance on the judgment of the Hon‟ble Supreme Court in the case of Navin Jindal v. Assistant Commissioner of Income Tax[187 Taxmann 283 [2010], wherein it was held as under:- “The right to subscribe to additional offer of shares/debentures on right basis on the strength of existing shareholding in the company comes into existence when the company decides to come out with the rights offer. Prior to that, such right, though embedded in the original shareholding, yet remains inchoate. The same crystallizes only when the rights offer is announced by the company. The said right to subscribe to additional shares/debentures 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.”

From the aforesaid observation of the Hon‟ble Supreme Court, it is evident that when a company offers right to the shareholders, the shareholder obtains an exercisable right to subscribe to shares which is different from the shares in the Indian company. In our view this observation of the Hon‟ble Supreme Court clearly clinches the issue that rights entitlement (REs) is distinct from the shares.

Our attention was also drawn to para 30 of OECD Model Tax Convention on Income & on Capital, 2017 wherein, it has been brought that gains from alienation of capital assets not covered elsewhere are taxable in the country of residence. The relevant extract of para 30 reads as under:- “30. The Article does not contain special rules for gains from the alienation of shares in a company (other than shares of a company dealt with in paragraph 4) or of securities bonds debentures and the like. Such gains are therefore taxable only in the State of which the alienator is a resident.”

However, it is seen that Article 13(4) & 13(5) of UN Model convention were amended in 2017 to expand their scope to include „other comparable interests‟ apart from shares. However, Article 13(5) of India-Ireland DTAA does not contain the mention of „other comparable interest‟ either in para 4 or para 5 of Article 13.

Now pursuant to introduction of MLI, India-Ireland DTAA was amended in the year 2019 and reference to “comparable interest” was included in Article 13(4) and not in Article 13(5). For the sake of ready reference Article 13(4) and Article 13(5) before the introduction of MLI and post introduction of MLI is as under:- Before amendment in 2019.

Thus, the two contracting states even while making the amendment post introduction of MLI have not included “comparable interest” in Article 13(5) which clearly indicate that Article 13(5) of India-Ireland DTAA only reference to share of a company and even Article 13(4) specifically defined “comparable interest” to include interest in partnership or trust. Thus, the rights entitlements are not included in Article 13(5) even after its amendment in 2019 post MLI. Accordingly, we are in tandem with the arguments of the ld. Counsel that rights entitlement does not fall within the ambit of alienation of shares.

To buttress this point of distinction, ld. Counsel for the assessee referred to clarification issued by the then Economic Affairs Secretary in respect of amendment to the India-Mauritius DTAA. In 2016, the India-Mauritius DTAA was amended which Vanguard Emerging Markets Stock Index Fund A Series of VISPLC re-allocated the taxation rights in respect of sale of shares between India and Mauritius. Pursuant to the amendment, India gained rights to tax gains arising on sale of share of Indian companies. At the time some ambiguity was perceived with regards to applicability of the amended provisions to gains arising on sale of other capital assets. The Government's stand was clarified by then Economic Affairs Secretary Mr. Shaktikanta Das to „Business Standard‟ news paper which has been quoted verbatim in an news article dated 21 August 2015, reproduced as under:- "Derivatives and other forms of securities, such as compulsory convertible debentures (CCDs) and optionally convertible debentures (OCDs) will continue to be governed by the existing provision of being taxed in Mauritius, said economic affairs secretary Shaktikanla Das. He said India had gained a source- based taxation right only for shares (equity) under the treaty Residence-based taxation will continue for derivatives under the Mauritius pact Meaning non-equity securities would be taxed in Mauritius if routed through there. But Mauritius does not have a short-term capital gains tax which would mean that investors using these instruments would continue to escape paying taxes in both countries. "There are three categories of instruments which arise between two countries-shares, immovable assets, and other instruments, including derivatives," he explained. "Insofar as shares are concerned, they are covered by the new agreement. As regards immovable property, all along the right to taxation is in India. The right to taxation is in the country where an immovable asset is located. So, if an immovable asset is located in India, we have the taxation right. With regard to other instruments, "the right to tax is always in that country. There cannot be a change that is the position all over the world". "It is their country's decision The right to tax is with that country with the US, the UK, Germany, Vanguard Emerging Markets Stock Index Fund A Series of VISPLC Japan, Mauritius, all the countries (with which India has a Double Taxation Avoidance Agreement), It is for that country to decide whether it wants to tax at 10, 20, or zero per cent (And) Just because some country has made it zero, I can't say I will tax, he further clarified"

Accordingly, it has been argued before us that even the stand of Government of India (through its Secretary in press) is that shares would cover “shares of Indian Company” and not derivatives & other securities. Accordingly, gain on alienation of securities other than shares would continue to be taxed in the resident country and not in India. The aforesaid clarification, clarifying the stand of the Government of India, if we look from the perspective of the distinction between the shares and other securities, then for the purpose of the present case, the rights entitlement which is distinct from shares can be taken as a guidance to see the intention of the Government while negotiating or amending the Articles of DTAA.

It is also a well settled proposition of law if any term has not been defined under the Act or treaty; the same is to be understood as per the domestic legislation in view of Section 90(3) of the Act as well as Article 3(2) of India-Ireland DTAA. It states that where the term has not been defined under the treaty, the meaning under the domestic tax legislation is to be adopted. Further, where the term has not been defined in domestic tax legislation also it is a general meaning is to be adopted. We find that the definition of shares even in Section 2(84) of the Companies Act, 2013 provides a restrictive Vanguard Emerging Markets Stock Index Fund A Series of VISPLC 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 under 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.

In so far as various observations of the ld.DRP to hold that rights entitlement is share only, point-wise rebuttal has been given by the ld. Counsel before us which for the sake of ready reference is reproduced herein below:-

The aforesaid 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.

In so far as 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, it has been submitted Vanguard Emerging Markets Stock Index Fund A Series of VISPLC that this issue stands covered by the decision of this Tribunal in the case of J.P. Morgan India Investment Company Mauritius Ltd. reported in 143 taxmann.com 82 wherein it has been held as under:- "Thus, the application of a treaty can result in the entire (gross) income being not subject to tax in India in a year where a taxpayer claims treaty benefits. Therefore, in a year in which a taxpayer claims benefit of article 13(4) of the India-Mauritius tax treaty, the entire gains he earns will not be taxable at all as India has given up its taxing rights in respect thereof. Thus, the entire amount of gains for the year (before setoff of brought forward losses) will go out of the taxing provisions if assessee has chosen to be assessed as per treaty. Thus, it is for an assessee to examine whether or not, in the light of the applicable legal provisions and in the light of the precise factual position, the provisions of the Income-tax Act are beneficial to him or that of the applicable double taxation avoidance agreement. Thus, these losses were therefore computed under the provisions of the Act, as in those earlier years, the assessee chose not to be governed by provisions of the treaty for those years but by the provisions of the Act. These provisions included the provisions of section 74 which deal with carry forward and set-off of these losses. The capital gain as per the Indian Mauritius DTAA is taxable in the resident country and the source country has given up its rights to tax the income. The Question of computation in the source country does not therefore arise. Accordingly, the income from capital gains is not taxable in India as per article 13(4) DTAA and accordingly, the mode of computation income in India as the source country will not arise. If the particular income is not to be taxed at all, the question of including the same under the total income and determining the taxability on the same will not arise and the contention of revenue that the total income as per Act is to be calculated to determine the tax liability and thereafter, the benefit is to be given cannot upheld. Accordingly, it is held that the tosses which have been brought forward from earlier years will be carried forward to the subsequent years without setting off the same against the gains of the previous year relevant to the Vanguard Emerging Markets Stock Index Fund A Series of VISPLC assessment year in Question for the reason that once the assessee has chosen the benefit of DTAA. then the capital gain is not at all taxable in India and therefore, there is no Question of setting off of loss from the earlier years.

Thus, this principle has been followed in catena of other judgments by this Tribunal. 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.

In so far as ground No.6 is concerned, assessee has stated that there is some error in the computation sheet appended with the order wherein ld. AO has erred in considering that a sum of Rs.56,686,590/- is refunded to the assessee, out of the total refund due to it amounting to Rs.98,959,800/-, whereas, the assessee has not received any such sum.

It has been stated that though application u/s.154 has been filed but it has not been disposed of by the ld. AO. Accordingly, we direct the ld. AO to consider the rectification application filed by the assessee and rectified the aforesaid mistake apparent from the record.

The other grounds challenging the validity of the assessment on account of non-issuance of notice u/s. 143(2) and certain Vanguard Emerging Markets Stock Index Fund A Series of VISPLC other grounds are dismissed as infructuous. Accordingly, appeal of the assessee is allowed on merits.

In the result, appeal of the assessee is allowed.