Dividend Stripping
This article deals with dividend and bonus stripping and the fact that if you aren’t careful, actions taken last year may come and bite in this one. However, we shall start at the beginning, when it all began.
Modified dividend stripping provisions
Stripping as a concept has generally always been frowned upon by the law. The Income Tax Act, also being a law, follows suit and takes a dim view of investors wantonly stripping securities of their income to get tax benefits.
It works this way. Say your mutual fund scheme is currently at an NAV of Rs. 35. It declares a 30% dividend. Now, dividend being on face value, this directly translates into Rs. 3 per unit. Post dividend, the NAV falls by Rs. 3 to Rs 32. Now, if you were one of those who strip securities for personal advantage, what you would do is to buy the scheme at Rs. 35, pocket the dividend of Rs. 3 and immediately sell the units post dividend at Rs. 32, thereby booking a notional loss of Rs. 3 per unit. Hold on….so far you haven’t really benefited financially. Now what you do is anytime during the financial year, earn short-term capital gains. It is at this time that the benefit kicks in. Marry the previously booked (notional) loss against this (very much real) gain and laugh all the way to the bank.
Authorities woke up to this tactic and didn’t like it one bit. Anti-stripping laws were passed with immediate effect and thus Sec. 94(7) was born. Budget 2004 gave this law sharper teeth. And now the way it stands is that whenever a person sells shares or units date and the following four conditions are simultaneously satisfied ---
1. The purchase has been within 3 months before the record date,
2. The sale has been within 3 months in the case of shares and 9 months in the case of units, after the record date
3. The dividend is tax-free and
4. The sale results in a loss (naturally, short-term).
the loss arising on the sale to the extent it does not exceed the exempt income has to be ignored.
For instance, take the following case ---
· Shares or units purchased on 4.4.05 at Rs. 500,
· Dividend distributed on 25.6.05 is Rs. 15 and
· Sale on 2.8.05 at Rs. 490, resulting in a loss of Rs. 10.
This loss shall be ignored for tax purposes and hence will be unavailable for set-off.
However, if the sale on 2.8.05 was at Rs. 480, resulting in a loss of Rs. 20, only Rs. 15 shall be ignored and Rs. 5 shall be allowed to be carried forward for set off against short-term gains or long-term gains in future for 8 successive years.
Similarly, if the sale on 2.8.05 was at Rs. 510 resulting in a profit of Rs. 10, the entire section is not applicable.
Bonus stripping provisions
Sec. 94(8) deals with bonus stripping. Interestingly, this section has been made applicable only for mutual fund units and not equities. I don’t have a clue why --- the reason is anybody's guess.
The stipulation for its applicability is identical with that of dividend stripping as propagated by the new Sec. 94(7), with only one primary difference:
· The loss, if any will also be ignored for the purposes of computing the income chargeable to tax. However, the amount of loss so ignored shall be deemed to be the cost of purchase or acquisition of the bonus units.
For clarity, let us take the same instance as dealt with above, but in this case, it is not the dividend but bonus units issued by a MF.
Units (and not shares) purchased on 4.4.05 at Rs. 500,
Bonus in the ratio of 1:1 distributed on 25.6.05.
Sale of the old base units on 2.8.05 at Rs. 350, resulting in a loss of Rs. 150.
This loss shall be ignored but the cost of acquisition of the bonus units will be taken as Rs. 150. Ordinarily the bonus units would have been valued at nil cost.
Take care of Retrospective Effect
Secs. 94(7) and 94(8) are more insidious than they seem --- their effect is not limited to the current financial year but might fall into the previous year (FY 04-05) too! This happens on account of the fact that all the conditions taken together can spawn twelve months in all thereby making the actions taken last year having ramifications in the current year too!
Let us understand this issue clearly by means of examples.
Situation 1
Investment in a MF scheme (doesn’t matter whether it is an income scheme or an equity scheme) is made on 5th January, 2005 and dividend is received on 31st March 2005. (Note that both these dates fall in FY 04-05). The investment is sold on 2nd April 2005 (FY 04-05). Is the short term loss arising out of this investment allowable for set-off against long-term or short-term capital gains FY 2004-05?
Situation 2
Investment in a MF scheme is made on 5th January, 2005 and bonus is received on 31st March, 2005. The original units are sold on 2nd August, 2005. Is the short term loss arising out of the original investment available for set-off?
Situation 3
Investment in a MF scheme is made on 1st December, 2004 and dividend is received on 31st March 2005. The investment is sold on 2nd June 2005. Is the short term loss arising out of this investment allowable for set-off against long-term or short-term capital gains FY 2005-06?
Situation 4
Investment in an MF scheme is made on 1st December, 2004 and bonus is received on 31st December, 2004. The original units are sold on 2nd November, 2005. Is the short term loss arising out of the original investment available for set-off?
Solutions
Situation-1 : The units are purchased within 3 months of the record date. Also, the units are sold within 9 months of the record date. It doesn’t matter that the date of sale falls in the next year. Or another way of looking at it would be that it doesn’t matter that the date of purchase or the record date fall in the previous financial year. As long as all the conditions laid out by Sec. 94(7) are being satisfied, the section would be applicable and consequently, the loss (to the extent of the dividend received) wouldn't be allowed for set-off.
Situation-2 : This situation is similar to the one above, only it deals with bonus units. Like mentioned above, it is irrelevant which financial year the transactions fall in, as long as the conditions of Sec. 94(8) (in this case) are satisfied, the section is attracted.
Situation-3 : Here readers will notice that the first condition is not being satisfied, in as much as, the time period between purchase and the record date for dividend is more than 3 months. Consequently, Sec. 94(7) is rendered ineffective and inapplicable.
Situation-4 : In this case, the sale is taking place well after the elapsing of 9 months after the record date. Hence, like situation 3 above, Sec. 94(8) is rendered ineffective and inapplicable.
Bottomline
The above analysis has been provided for readers to get a good grip on the ramifications of the provisions of dividend and bonus stripping. Incidentally, a tip for those (corporate as well as individual investors) who have existing short-term loss. You can tweak the bonus stripping provisions this way --- sell the bonus units first! This way you render Sec. 94(8) impotent. Marry the short-term gain that you have earned this way against your short-term loss. And now when you sell the original units, the notional loss is available for the taking.
Source: Money control-Tax specialist
Modified dividend stripping provisions
Stripping as a concept has generally always been frowned upon by the law. The Income Tax Act, also being a law, follows suit and takes a dim view of investors wantonly stripping securities of their income to get tax benefits.
It works this way. Say your mutual fund scheme is currently at an NAV of Rs. 35. It declares a 30% dividend. Now, dividend being on face value, this directly translates into Rs. 3 per unit. Post dividend, the NAV falls by Rs. 3 to Rs 32. Now, if you were one of those who strip securities for personal advantage, what you would do is to buy the scheme at Rs. 35, pocket the dividend of Rs. 3 and immediately sell the units post dividend at Rs. 32, thereby booking a notional loss of Rs. 3 per unit. Hold on….so far you haven’t really benefited financially. Now what you do is anytime during the financial year, earn short-term capital gains. It is at this time that the benefit kicks in. Marry the previously booked (notional) loss against this (very much real) gain and laugh all the way to the bank.
Authorities woke up to this tactic and didn’t like it one bit. Anti-stripping laws were passed with immediate effect and thus Sec. 94(7) was born. Budget 2004 gave this law sharper teeth. And now the way it stands is that whenever a person sells shares or units date and the following four conditions are simultaneously satisfied ---
1. The purchase has been within 3 months before the record date,
2. The sale has been within 3 months in the case of shares and 9 months in the case of units, after the record date
3. The dividend is tax-free and
4. The sale results in a loss (naturally, short-term).
the loss arising on the sale to the extent it does not exceed the exempt income has to be ignored.
For instance, take the following case ---
· Shares or units purchased on 4.4.05 at Rs. 500,
· Dividend distributed on 25.6.05 is Rs. 15 and
· Sale on 2.8.05 at Rs. 490, resulting in a loss of Rs. 10.
This loss shall be ignored for tax purposes and hence will be unavailable for set-off.
However, if the sale on 2.8.05 was at Rs. 480, resulting in a loss of Rs. 20, only Rs. 15 shall be ignored and Rs. 5 shall be allowed to be carried forward for set off against short-term gains or long-term gains in future for 8 successive years.
Similarly, if the sale on 2.8.05 was at Rs. 510 resulting in a profit of Rs. 10, the entire section is not applicable.
Bonus stripping provisions
Sec. 94(8) deals with bonus stripping. Interestingly, this section has been made applicable only for mutual fund units and not equities. I don’t have a clue why --- the reason is anybody's guess.
The stipulation for its applicability is identical with that of dividend stripping as propagated by the new Sec. 94(7), with only one primary difference:
· The loss, if any will also be ignored for the purposes of computing the income chargeable to tax. However, the amount of loss so ignored shall be deemed to be the cost of purchase or acquisition of the bonus units.
For clarity, let us take the same instance as dealt with above, but in this case, it is not the dividend but bonus units issued by a MF.
Units (and not shares) purchased on 4.4.05 at Rs. 500,
Bonus in the ratio of 1:1 distributed on 25.6.05.
Sale of the old base units on 2.8.05 at Rs. 350, resulting in a loss of Rs. 150.
This loss shall be ignored but the cost of acquisition of the bonus units will be taken as Rs. 150. Ordinarily the bonus units would have been valued at nil cost.
Take care of Retrospective Effect
Secs. 94(7) and 94(8) are more insidious than they seem --- their effect is not limited to the current financial year but might fall into the previous year (FY 04-05) too! This happens on account of the fact that all the conditions taken together can spawn twelve months in all thereby making the actions taken last year having ramifications in the current year too!
Let us understand this issue clearly by means of examples.
Situation 1
Investment in a MF scheme (doesn’t matter whether it is an income scheme or an equity scheme) is made on 5th January, 2005 and dividend is received on 31st March 2005. (Note that both these dates fall in FY 04-05). The investment is sold on 2nd April 2005 (FY 04-05). Is the short term loss arising out of this investment allowable for set-off against long-term or short-term capital gains FY 2004-05?
Situation 2
Investment in a MF scheme is made on 5th January, 2005 and bonus is received on 31st March, 2005. The original units are sold on 2nd August, 2005. Is the short term loss arising out of the original investment available for set-off?
Situation 3
Investment in a MF scheme is made on 1st December, 2004 and dividend is received on 31st March 2005. The investment is sold on 2nd June 2005. Is the short term loss arising out of this investment allowable for set-off against long-term or short-term capital gains FY 2005-06?
Situation 4
Investment in an MF scheme is made on 1st December, 2004 and bonus is received on 31st December, 2004. The original units are sold on 2nd November, 2005. Is the short term loss arising out of the original investment available for set-off?
Solutions
Situation-1 : The units are purchased within 3 months of the record date. Also, the units are sold within 9 months of the record date. It doesn’t matter that the date of sale falls in the next year. Or another way of looking at it would be that it doesn’t matter that the date of purchase or the record date fall in the previous financial year. As long as all the conditions laid out by Sec. 94(7) are being satisfied, the section would be applicable and consequently, the loss (to the extent of the dividend received) wouldn't be allowed for set-off.
Situation-2 : This situation is similar to the one above, only it deals with bonus units. Like mentioned above, it is irrelevant which financial year the transactions fall in, as long as the conditions of Sec. 94(8) (in this case) are satisfied, the section is attracted.
Situation-3 : Here readers will notice that the first condition is not being satisfied, in as much as, the time period between purchase and the record date for dividend is more than 3 months. Consequently, Sec. 94(7) is rendered ineffective and inapplicable.
Situation-4 : In this case, the sale is taking place well after the elapsing of 9 months after the record date. Hence, like situation 3 above, Sec. 94(8) is rendered ineffective and inapplicable.
Bottomline
The above analysis has been provided for readers to get a good grip on the ramifications of the provisions of dividend and bonus stripping. Incidentally, a tip for those (corporate as well as individual investors) who have existing short-term loss. You can tweak the bonus stripping provisions this way --- sell the bonus units first! This way you render Sec. 94(8) impotent. Marry the short-term gain that you have earned this way against your short-term loss. And now when you sell the original units, the notional loss is available for the taking.
Source: Money control-Tax specialist
posted by Unknown at 9:32 PM
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