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.
- 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 unit of Mutual Funds or units of Unit Trust of India.
- Buying or acquiring ay 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.
- Please note that dividend on share is exempt u/s 10(34) and dividend/income on 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.
Section 94(8) has been inserted with effect form 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 (atleast one) of the additional units (bonus units).
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 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.