Dividend Stripping and Bonus Stripping

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Dividend Stripping and Bonus Stripping

Dividend Stripping : Sec-94(7) of the Income Tax Act – 1961, deals with the provisions related to the dividend stripping.

What does “dividend stripping” means?

Dividend stripping is a attempt to reduce the tax liability, by an investor who invests in securities (i.e. shares, stock or debentures etc.) and units (Mutual fund units or units of UTI), shortly before the record date and getting a tax free dividend/income, and exiting after the record date at a price lower than the price at which, such securities/units were purchased and incurring a short-term capital loss.

The strategy behind dividend stripping is a two way strategy wherein-

– Investor gets tax free dividend (i.e. exempted u/s 10(34)/10(35))

– Incurs Short term capital loss (i.e. allowed to be set off and carry forward)

Record date:- Date fixed by a company or mutual funds for the purpose of entitlement of holders of securities or units, to receive dividend or other income.

Hence, provisions of sec-94(7) come into force to curb the investors to gain double benefit, by way of dividend stripping. Sec 94(7) specified the conditions to be satisfied to attract the provisions of this section which are as follows:-

Conditions to be satisfied to attract the provisions of sec – 94(7) :

ConditionsSecuritiesUnits
Buying or acquiringWithin a period of 3 months prior to the record dateWithin a period of 3 months prior to the record date
Selling or transferringWithin a period of 3 months after the record dateWithin a period of 9 months after the record date
Dividend or income during intervening periodExemptExempt

Note : All the conditions are required to be satisfied to attract the provisions of sec – 94(7) of Income Tax Act – 1961.

Consequence if above mentioned conditions are satisfied-

If the above mentioned conditions are met, then the short term capital loss, if any, arising to the investor on purchase and sale of such securities or units, not exceeding the amount of dividend or income received/receivable on such securities or units, shall not be considered while computing the total income chargeable to tax.

Even, u/s 94(7) the short term capital loss arising, shall not be allowed to be set-off or carried forward, to the extent of dividend or income received.

Notes: – 1) According to the provisions of sec – 10(34) of IT Act 1961, dividend received on shares is exempt in the hands of shareholders. And as per sec -10(35) dividend or any income received on units is exempt in the hands of unit holders.

2) According to the provisions of sec-115BBDA, (introduced by Finance Act, 2017) exemption u/s 10(34) is not available if the amount of dividend exceeds Rs. 10Lakhs. Hence, if dividend received exceeds Rs. 10Lakhs then, such excess amount shall be chargeable to tax @ 10% in the hands of shareholders.

3) Sec-94 covers the holding of securities/units both as capital assets and as stock-in-trade. Hence sec-94(7) would be applicable to both an investor and trader of securities/units.

Example: – Mr. A purchases 10,000 equity shares of X Ltd. on 30th May, 2017 for Rs. 50 each. X Ltd.’s record date for declaration of dividend @ Rs. 5 per share, being 10th of August, 2017.  Mr. A sold 7,000 equity shares at Rs. 35 per share on 28th September, 2017 and the balance 3,000 equity shares at Rs. 25 per share on 18th December, 2017.

S.No.ParticularsCalculation in different cases (Amount in Rs.)
 7000 shares (SP – Rs. 35)

Sold on 28.09.2017

3000 shares (SP –Rs. 25)

Sold on 18.12.2017

ASales Value2,45,00075,000
BCost of Acquisition3,50,0001,50,000
CShort Term Capital Loss (A-B)1,05,00075,000
DDividend received35,00015,000

-Total Short term capital Loss = Rs. 1,80,000/- (i.e. 1,05,000 + 75,000)

-Dividend exempt u/s 10(34) = Rs. 50,000/- (i.e. 35,000 + 15,000)

Consequence: – According to the provisions of sec – 94(7) ,Out of the total short term capital loss of Rs. 1,80,000/-, loss amount to Rs. 35,000/- (i.e. amount equivalent to the dividend received on 7,000 shares) shall not be allowed to be set off or carried forward.

Hence, Only Rs. 1,45,000/- of Short term capital loss is allowed to be carried forward.

Bonus Stripping: – Sec-94(8) of the Income Tax Act – 1961, deals with the provisions related to the Bonus stripping.

Bonus stripping provides, that the loss, if any, arising to an investor on account of purchase and sale of Original units shall be ignored for the purpose of computing his total income chargeable to tax, subject to the following conditions-

Conditions to be satisfied to attract the provisions of sec – 94(8)

ConditionsUnits*
Bought or acquired (Original units)Within a period of 3 months prior to the record date
Allotment of additional units (Bonus units)Without any payment on such record date
Sold or transferred (Original units)Within 9 months after the record date
Holds atleast one additional bonus unitOn the date of such sale or transfer of original units

*Provisions of sec- 94(8) are applicable only in respect of units and not for shares.

Hence, if the above conditions are met, the loss will be considered to be the cost of acquisition of the bonus units held on the date of sale. (Benefit of indexation is available on such cost of acquisition)

Notes: – 1) The provisions of sec- 94(8) are applicable, even in case of units are held as stock-in-trade.

2) The provisions of sec- 94(8) are not applicable, in case all the additional units (bonus units) are transferred before the original units are sold.

For Example – 1 Stanford mutual funds declare 1:1 bonus units on its units on 30th April, 2017. The record date for bonus units issue fixed to be 31st of May, 2017. Mr. A purchases 10,000 units (Original units) of Stanford mutual funds on 15th May, 2017 at a rate of Rs. 50 per unit. Mr. A sells 10,000 original units on 15th December, 2017 at a rate of Rs. 35 per unit.

S.No.Particulars    Calculation (Amount in Rs.)   
ASales value (10000 x 35)3,50,000
BCost of acquisition (10000 x 50)5,00,000
CShort term capital Loss (A-B)1,50,000
DNo. of bonus units10,000

Consequence:- According to the provisions of sec- 94(8) of IT Act – 1961, The Short term capital loss amount to Rs. 1,50,000/- shall not be considered in computing the total income and such short term capital loss shall neither be set off nor be carried forward.

Hence, the cost of acquisition of 10,000 bonus units shall be taken to be Rs. 1,50,000.

Example – 2:- If in above example, Mr. A sells 10,000 original units on 15th December, 2017 at a rate of Rs. 35 per unit and 7,000 units of such bonus units at a rate of Rs. 35 per unit on 20th December, 2017 then-

S.No.ParticularsCalculation (Amount in Rs.)
  Original units (10,000)Bonus units (7,000)
ASales value3,50,0002,45,000
BCost of acquisition5,00,0001,05,000*
CShort term capital Loss/Gain (A-B)(1,50,000)1,40,000

Consequence:- According to the provisions of sec- 94(8) of IT Act – 1961, The Short term capital loss amount to Rs. 1,50,000/- shall not be considered in computing the total income and such short term capital loss shall neither be set off nor be carried forward. Hence, the cost of acquisition of 10,000 bonus units shall be taken to be Rs. 1,50,000.

*Cost of acquisition of 7,000 bonus units = 1,50,000 x 7,000/ 10,000 = Rs. 1,05,000

The Short term capital gain on sale of bonus units Rs. 1,40,000 shall be taxable.

Example – 3:- If in example 1, Mr. A sells all the 10,000 bonus units on 20th October, 2017 at a rate of Rs. 35 per unit and 10,000 original units on 15th December, 2017 at a rate of Rs. 35 per unit then-

 ParticularsCalculation (Amount in Rs.)
  Original units (10,000)Bonus units (10,000)
ASales value3,50,0003,50,000
BCost of acquisition5,00,000NIL
CShort term capital Loss/Gain (A-B)(1,50,000)3,50,000

Consequence: – In this case, the provisions of sec- 94(8) are not applicable since as on the date of sale of original units, the assessee does not hold any additional bonus unit. The Short term capital loss amount to Rs. 1,50,000 is allowed to set off and carried forward.

Disclaimer: The contents of this article have been prepared in accordance with the relevant provisions, and information available at the time of preparation. The views and opinions expressed in this article are those of the author and the author does not take any responsibility and cannot guarantee that no inaccuracy occurs. This article cannot be quoted without the consent of the author.

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