Tribunal Affirms Tax Exemption for FPIs on Rights Entitlements under the India-Ireland DTAA

Introduction

Reinforcing the settled principles under international tax jurisprudence, the Hon’ble Income Tax Appellate Tribunal, Mumbai Bench, in the case of Vanguard Emerging Markets Stock Index Fund v. Assistant Commissioner of Income-tax[i], engages with the nuanced issue of taxability of capital gains arising from the sale of ‘Rights Entitlements’ (‘REs’) by a Foreign Portfolio Investor (‘FPI’) under the India-Ireland Double Taxation Avoidance Agreement (‘DTAA’). It reinforces the critical distinction between shares and rights entitlements, particularly under a. 13 of the DTAA, and adopts a purposive interpretation of the provision to uphold India’s limited taxing rights under a. 13(6) for assets not specifically enumerated in the earlier clauses. It further settles the question of whether capital losses under domestic law can be set off against capital gains that are exempt under a tax treaty.

Brief Facts

• Vanguard Emerging Markets Stock Index Fund (‘Assessee’) is an FPI registered with SEBI and a tax resident of Ireland. During the relevant financial year, it earned short-term capital gains on the sale of REs of Indian company shares and claimed exemption on such gains under a. 13(6) of the DTAA.

• The assessee contended that the REs constitute a class of assets distinct from equity shares and hence do not fall within a. 13(4) or a. 13(5) of the DTAA, which deal with shares and comparable interests.

• The Assessing Officer (‘AO’), however, disagreed, asserting that the REs and shares are closely linked, and thus, gains arising therefrom ought to be taxed in India under a. 13(5). Further, the AO proceeded to adjust such gains against the Assessee’s brought-forward short-term capital losses.

• On objections raised by the Assessee, the Dispute Resolution Panel (‘DRP’) upheld the AO’s view, holding REs to be akin to equity shares.

• Aggrieved, the Assessee preferred an appeal before the Tribunal, contending that REs are legally and economically distinct from shares and fall under a. 13(6) of the DTAA.

Held

The Tribunal ruled in favour of the Assessee and held as follows:

• The REs sold by the Assessee are a separate category of capital asset from equity shares, and are not covered within the ambit of a. 13(5) of the DTAA, which only governs taxation of gains arising from the alienation of shares in an Indian company.

• Consequently, such gains fall within a. 13(6) of the DTAA, which provides that capital gains arising from the alienation of any property not referred to in paragraphs 1 to 5 shall be taxable exclusively in the resident country, i.e., Ireland in the present case.

• The Tribunal placed reliance on the decision of the Hon’ble Supreme Court in Navin Jindal v. ACIT[ii], which held that the right to subscribe to additional shares is a separate and independent right, capable of being renounced or transferred, and hence cannot be equated with the underlying shares.

• Regulatory framework, including SEBI circulars and NSE notifications, also recognizes REs as separate securities by assigning them distinct International Securities Identification Numbers (‘ISINs’) and treating them as ‘options in securities’ rather than shares.

• The Tribunal further noted that even after the DTAA was amended pursuant to the Multilateral Instrument, the term ‘comparable interest’ was only introduced in a. 13(4) and not in a. 13(5), thereby excluding REs from the scope of taxable shares under a. 13(5).

• On the issue of set-off, the Tribunal observed that since the capital gains from REs are not chargeable to tax in India under the DTAA, such exempt gains cannot be included in the computation of total income under the Income-tax Act,1961 ('Act') and therefore, cannot be set off against Indian-sourced capital losses.

• In doing so, the Tribunal followed its earlier decision in ACIT v. J.P. Morgan India Investment Co. Mauritius Ltd.[iii], wherein it was held that where income is exempt under a treaty, it is to be excluded altogether from the scope of computation under the Act.

• Accordingly, the Tribunal quashed the findings of the AO and the DRP and allowed the appeal in favour of the Assessee.

Our Analysis

This judgment reaffirms the sanctity of tax treaty provisions by preventing undue extension of India’s taxing jurisdiction in a cross-border investment context.

The Tribunal engaged in a layered interpretation of REs drawing from corporate law, securities regulations, and tax jurisprudence, clearly establishing that REs are separate marketable rights, different from shares, with distinct economic and legal characteristics. The Tribunal also rightly relied on judicial precedent and statutory interpretation (e.g., s.2(42A) and s.55(2)(aa) of the Act), which treat REs as independent capital assets.

Importantly, the Tribunal avoided adopting a ‘substance over form’ approach that could have undermined treaty protections. Instead, it honoured the literal and contextual interpretation of Article 13, noting that the India-Ireland DTAA, unlike the UN Model, does not expand Article 13(5) to include ‘comparable interests’ such as REs or derivatives.

The Tribunal also made a crucial clarification on the interaction between treaty-exempt income and domestic set-off provisions. It rightly held that income exempt under the DTAA should not be brought into the computation mechanism of the Act, even for the limited purpose of adjusting losses.

In its practical impact, this ruling provides significant clarity and relief to FPIs, especially those involved in rights trading, which has gained traction post-SEBI’s dematerialisation reforms. It also affirms that taxation of capital gains by India under treaties must be narrowly construed, in accordance with negotiated language and not expanded by analogy or judicial creativity.

End Notes

[i] [2025] 172 taxmann.com 515 (Mumbai - Trib.)[18-03-2025].

[ii] [2010] 187 Taxman 283 (SC)/[2010] 320 ITR 708 (SC)/[2010] 228 CTR 478 (SC)[11-01-2010].

[iii] [2022] 143 taxmann.com 82 (Mumbai - Trib.)/[2023] 198 ITD 392 (Mumbai - Trib.)[27-09-2022].

Authored by Ritik Kumar Jha, Advocate at Metalegal Advocates. The views expressed are personal and do not constitute legal opinions.