Strategy behind Dividend Stripping
Dividend stripping is a strategy to reduce the tax burden, by which an investor gets tax free dividend by investing in securities (including units), shortly before the record date and exiting after the record date at a lower price, thereby incurring a short-term capital loss. This short-term capital loss is compensated with the tax-free dividend. Further, the investor can set off such loss against capital gains – both short-term and long-term – as the law stands at present and can also carry forward the unabsorbed loss for set off in future years.
In simple words, the benefits of dividend stripping is that, on one side, the investor would earn a tax-free/exempt dividend or income [under sections 10(34) and 10(35) of the I. T. Act] and, on the other side, he would suffer a short-term capital loss i.e. difference between the cum-dividend price and ex-dividend price, which is available to be utilized or carry forward by the taxpayer for reducing his present or future tax liability.
- Record date means a date fixed by a Company or Mutual Fund for the purposes of entitlement of the holders of the securities to receive dividends or income.
- Securities include stocks and shares.
- Units mean a unit of Mutual Funds or units of Unit Trust of India.
Applicability of provisions relating to Dividend Stripping
- Buying or acquiring any securities or units within a period of three months prior to the record date.
- Selling or transferring such securities within a period of three months after such date, or such units within a period of nine months after such date;
- the dividend or income on such securities or unit received or receivable by such person during the intervening period is exempt from tax.
All the above conditions should be fulfilled for applicability of section 94(7), if any of the conditions are not satisfied then this section will not be applicable.
- Please note that dividend on a share is exempt u/s 10(34) and dividend/income on a unit is exempt u/s 10(35).
- Section 94 covers holding of securities or units both as capital assets and as stock-in-trace and hence section 94(7) would be applicable to both an investor as well as a trader of securities or units.
Bonus Stripping u/s 94(8)
Section 94(8) has been inserted with effect from the assessment year 2005-06 to curb the practice of creation of losses via Bonus Stripping. Briefly, it says that the loss, if any, arising to a person on account of purchase and sale of original units shall be ignored for the purpose of computing his income chargeable to tax if the following conditions are satisfied:
- The person buys or acquires any units within a period of 3 months prior to the record date,
- He is allotted additional units (bonus units) without any payment on the basis of holding of such units on such date,
- He sells or transfers all or any of the units excluding bonus units within a period of 9 months after such date,
- On the date of sale or transfer, he continues to hold all or any (at least one) of the additional units (bonus units).
Then the amount of loss so ignored shall be deemed to be the cost of purchase or acquisition of such additional units as are held by him on the date of such sale or transfer.
Remember all the above-stated conditions have to be cumulatively fulfilled in order to attract section 94(8).
The Provision of Bonus Stripping under section 94(8)
- Applies to all units whether bought or acquired
- covers both open ended and close ended equity funds
- is applicable even in a case where units are held as stock in trade
- is applicable only in respect of units and not shares
- does not apply if all additional units are transferred before the original units are sold.
Indexed cost of Acquisition: Since the loss is considered to be the cost of acquisition of the bonus units held on the date of sale, the benefits of indexation should be available on such deemed cost of acquisition.