Transactions relating to Indian depository receipts (IDRs), a type of security recently been issued for the first time in India by Standard Chartered Plc, gives rise to interesting taxation issues, particularly since the tax laws have no specific provisions for IDRs.

Standard Chartered came out last month with a rights issue of shares. IDR holders, however, were not given the option of subscribing to IDRs proportionate to their entitlement, but instead received money in lieu of their rights entitlements. What is the tax treatment of such money received by the IDR holders? Is it taxable as normal income as income from other sources or as capital gains?

The tax rates would be the same for both short-term capital gains as well as normal income. However, in the case of normal income, other capital losses cannot be set off against such income, while capital losses can be set off against short-term capital gains.

Normally, in the case of shares and securities held as investments (capital assets), where the holder of the shares or securities becomes entitled to subscribe to an additional security by virtue of holding the shares or securities, and instead of subscribing to the additional security, renounces such rights entitlements, the entire sales proceeds is taxable as short-term capital gains. This is on account of the fact that the rights entitlements is regarded as a separate capital asset which comes into existence when the rights offer opens and its cost is deemed to be nil. In the case of Standard Chartered, can one say that the IDR holder was entitled to the rights entitlements and that this has been renounced by him?

Illustration: Shyamal Banerjee/Mint

IDRs are certainly securities and IDR holders were entitled to certain rights shares. It is, therefore, clear that the amount received by IDR holders is taxable in the same manner as the direct sale of rights entitlements by a shareholder of an Indian company would have been taxable. In other words, the entire amount received by IDR shareholders would be taxable as short-term capital gains, with the cost of acquisition being nil.

What would be the tax rate on such short-term capital gains? Can one claim the concessional rate of 15% applicable to listed equity shares or units? It needs to be kept in mind that what has been sold is not equity shares or units, but rights entitlements to equity shares, which is quite distinct. Further, the concessional rate of tax is available only if securities transaction tax (STT) has been paid on the sale. The rights entitlements having been sold in the UK market and not in the Indian stock markets, obviously STT has not been paid on the sale. Therefore, such short-term capital gains would be taxable at the normal slab rates applicable to the taxpayer.

For a person who is a dealer in securities and holds IDRs as his stock-in-trade, the amount received by him towards the IDR rights would of course constitute his normal business income, and would also be taxable at normal slab rates.

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Gautam Nayak is a chartered accountant.