Since 2019, SEBI has permitted the trading of Rights Entitlements (REs) on stock exchanges, offering investors the choice to apply for more shares, increase their rights, or sell them. Trading these short-term instruments offers opportunities but requires a good grasp of pricing, timelines, tax implications, and strategy. This chapter will guide you through the process of Rights Entitlement trading, how RE prices are set, the decision-making process between applying or selling, the concept of "renunciation," and strategic uses of REs.
Rights Entitlements Overview
Rights Entitlements (REs) are temporary credits in your demat account, indicating how many additional shares you can apply for in a rights issue. It's important to note that REs themselves are not the rights issue shares. They appear under a distinct ISIN, like ABC-RE, and come with an expiration date. If you don't act on them before the closure of the issue, unutilized REs will lapse and lose their value.
Rights Entitlement (RE) vs. Rights Issue, Key Differences
While Rights Entitlement and Rights Issue might sound similar, they represent different aspects of the process:
Rights Issue
- This is the company's formal offer to existing shareholders.
- It allows shareholders to purchase additional shares at a lower price.
- It includes details like the issue price, record date, share ratio, application period, and allotment steps.
Rights Entitlement (RE)
- RE represents your share of that offer, credited to your demat account.
- It shows how many shares you can apply for in the rights issue.
- Unlike the rights issue, REs can be traded, sold, or renounced.
Trading of Rights Entitlements
Trading of Rights Entitlements refers to the buying or selling of REs during a specified window. This is also called Renunciation of Rights Entitlement, which means a shareholder is choosing to transfer some or all of their rights to someone else.
Types of Renunciation
On-Market Renunciation
Off-Market Renunciation
The Purpose Behind RE Trading
RE trading offers flexibility to both parties involved:
For Shareholders Not Interested in Applying
They can sell their REs to gain value instead of letting them expire worthless.
For Investors Seeking More Shares
They can purchase REs from the market and apply for additional shares.
By allowing this trading, rights issues become more inclusive and efficient.
Mechanics of RE Trading
There are two primary methods for trading REs:
(A) On-Market Trading
This is the most prevalent method, also known as on-market renunciation. REs trade on the stock exchange similar to shares, albeit with some restrictions.
Key Points:
- Trading occurs during a limited window while the rights issue is open.
- Orders can be placed through your broker, similar to regular stock trades.
- Intraday trading is prohibited.
- Settlements occur on a T+1 basis.
- Completing trades 2–3 days before the issue closes is advised to ensure application time.
(B) Off-Market Renunciation
This method is less common and typically involves private transfers.
Features:
- Buyer and seller agree on the price mutually.
- Procedures are outlined in the Letter of Offer.
Decisions to Buy or Sell RE
Before deciding whether to apply for rights shares or sell your RE, it's wise for investors to estimate the fair value of the RE. This helps gauge if the market price is attractive or overpriced.
(i) Determining the Value of the RE
A popular method involves calculating the Risk-Adjusted Share Price (RASP), the anticipated share price post-rights issue, and deriving the intrinsic value of the RE from there.
Example: Calculating Theoretical Value of RE
- Shares held: 600
- Rights ratio: 1:9 → You receive 66 REs
- Rights issue price: ₹150
- Current Market Price (CMP): ₹210
Formula for RASP
= (Value of existing shares + Value of rights shares) ÷ Total shares after issue = (600×210 + 66×150) / 666= ₹204
Fair value of RE
= RASP – Rights issue price = 204 – 150 = ₹54
Thus, the theoretical value of each RE = ₹54
This provides a benchmark against which the actual trading price of the RE can be compared.
(ii) Compare Fair Value With Actual Market Price
Once the fair value is known, compare it with the RE's current market price:
- If RE market price > Fair value (e.g., RE trades at ₹55 vs. fair value ₹54) → Selling might be preferable.
- If RE market price < Fair value (e.g., RE trades at ₹40–45) → Applying for rights shares could be more beneficial.
This comparison aids in making a swift, logical decision.
(iii) If You Are Not Applying, Selling is Advisable
Even if you decide against participating in the rights issue:
✔ Always sell the RE instead of letting it lapse.
✔ RE holds monetary value during the trading window.
✔ Letting it expire means missing out on that value entirely.
Selling ensures some value recovery, whereas inaction results in none.
While the theoretical and market values of the Rights Entitlement (RE) are crucial indicators, pricing should not be the sole factor in your decision. It's also essential to evaluate the company's fundamentals and future outlook.
Before deciding whether to apply for rights shares or sell the RE, consider:
- The company's purpose for raising funds (debt reduction, expansion, financial distress?)
- Financial health, profitability, debt levels, cash flow
- Management's track record and governance
- Industry outlook and competitiveness
- Recent price performance and potential catalysts
A rights issue can be a positive opportunity if the company is raising funds for growth or to strengthen its balance sheet. However, if driven by financial distress, even a discounted offer may not be wise.
Buy Rights Entitlement
To purchase additional rights entitlements from the market, investors can log into their brokerage platforms and buy REs online during the trading period, then apply for all held REs.
Important to note:
- Buying RE does not guarantee allotment unless you also submit the rights application.
- If you buy REs and neglect to apply → REs become worthless.
Sell Rights Entitlement
Selling Rights Entitlement is akin to selling regular shares but is time-sensitive and strictly delivery-only (No intraday).
Steps to sell REs on-market:
- Log in to your brokerage app.
- Search for the RE symbol (e.g., XYZ–RE).
- Set your price and sell.
- Ensure you sell before RE trading closes.
Tax Implications of Rights Entitlements
The tax treatment of Rights Entitlements (REs) is straightforward. Selling an RE on the market is considered a capital gain since REs are categorized as a capital asset. Because they are credited to you at no cost, the acquisition cost is NIL, making the entire selling price taxable. REs are typically short-lived, so any gains are usually short-term capital gains (STCG).
If you choose not to sell or apply, the RE simply lapses, there's no tax impact and no capital loss claim. When you apply and receive rights shares, tax rules apply only when you sell those shares in the future. The acquisition cost for such shares is the amount paid during the rights issue, and the holding period starts from the date of allotment.
| Scenario | Tax Treatment |
|---|---|
| Selling REs | Taxed on entire sale value as STCG |
| REs Lapse (Not sold / Not applied) | No tax impact. Cannot claim capital loss for lapsed REs. |
| Applying for Rights Shares | Tax applies as STCG or LTCG depending on holding period only when shares are sold. (Selling amount - amount paid to acquire rights) |
Key Takeaways
- REs offer shareholders the choice to apply for rights shares or sell the entitlement.
- REs can be traded only in renounceable issues and within the trading window.
- Compare RE value with market price and evaluate the company's outlook before deciding to apply or sell.
- RE trading is strictly delivery, not intraday.
- Tax rule: Selling RE → capital gains (cost = NIL).
