Dividend Striping- A new look after amendment in Budget 2020 and Bonus Stripping

[Rishabh Jain]

Dividend Striping- A new look after amendment in Budget 2020 and Bonus Stripping

1. Dividend stripping: The method of dividend stripping used to be applied extensively to save tax on short-term gains. This practice involved, buying security or unit on or just prior to the record date for declaration of dividend, pocketing the tax-free dividend amount and selling the units at the ex-dividend NAV thereby incurring a notional short-term capital loss. This (notional) capital loss could be used to set off other capital gain on which tax would otherwise have been payable. The loss is notional in nature, yet it can be used to set off actual capital gain.

Section 94(7)

As per sec. 94(7), where-

 (a) any person buys or acquires any securities or unit within a period of three months prior to the record date;

 (b) such person sells or transfers-

   (i) such securities within a period of three months after such date; or

  (ii) such unit within a period of nine months after such date;

 (c) the dividend or income on such securities or unit received or receivable by such person is exempt,

then, the loss, if any, arising to him on account of such purchase and sale of securities or unit, to the extent such loss does not exceed the amount of dividend or income received or receivable on such securities or unit, shall be ignored for the purposes of computing his income chargeable to tax.

Analysis:-

All the three conditions must be satisfied before sec. 94(7) is attracted. Thus, if the shares are acquired before the period of three months prior to record date, section 94 (7) shall not apply. Similarly, if such shares are sold after three months of the record date, section 94(7) shall not be applicable.

‘Record date’ means such date as may be fixed by a company or a Mutual Fund or the Unit Trust of India for the purpose of entitlement of the holder of the securities or the unit holder to receive dividend or income, as the case may be.

Is Dividend striping still possible ?

As per Budget 2020, since DDT (Dividend Distribution Tax) is abolished w.e.f. 01.04.2020, dividend would now be taxable in the hands of the shareholders at the respective tax rates applicable to shareholders. The Indian company will be required to withhold tax on dividend at the following rates:

Particulars	Tax rate (excluding surcharge and health and education cess
Dividends paid to resident shareholders, exceeding ₹ 5,000	10%
Dividends paid to non-resident shareholders, including NRIs	20% or Rate as per DTAA
Dividend paid to FPIs	20%
Dividends paid on GDRs / ADRs	10%

However, no change has been made to Sec 94(7).

In my opinion, since the shareholder would be paying tax on dividend, he would also be allowed to claim the entire capital loss instead of capital loss to the extent of dividend amount in the earlier provision. However, no such clarification is issued by the Income Tax Department. Hence, it would be interesting to see how these provisions work in near future. Dividend stripping provisions will become redundant w.e.f. 01.04.2020 or not.

Example 1:

• Suppose Record Date for Dividend /Income 31.01.2021
• Acquisition of Shares / Units of MF

– Within 3 months prior to the record date (01.11.2020 till 31.01.2021)

Sale or Transfer of

• Shares within 3 months after the record date (01.02.2021 till 30.04.2021)
• Units of MF within 9 months after the record date (01.02.2021 till 31.10.2021)

In such a case, short term capital loss if any arising on the sale of such Shares / MF Units shall be ignored to the extent of dividend / income received or receivable thereon.

Mr. A purchase of securities/units linked to share of a company on which dividend is payable, at a price, say ₹ 1000. Mr. A by holding on the investment in the above securities/securities linked to share of a company enjoying the benefit of dividend distributed on such investment, say ₹ 100. Mr. A sale these securities/units linked to shares of a company at a lower price, say ₹ 850.This fall in price of the shares/units linked to share of a company is largely attributable to the dividend payout.

Dividend distributed by a company is taxable in the hands of its shareholders w.e.f. A.Y. 2021-22. However, the taxpayer may claim a carry forward or setoff of the loss arising from selling the shares/units linked to shares of a company at a lower price.

Another section 94(7) of the Income Tax Act provides that only so much of loss is available for set-off or carry forward, which exceeds the amount of dividend earned on the shares/units linked to share of a company.

In the above mentioned example

The taxpayer would have incurred a loss of ₹ 150 by virtue of sale and purchase of shares (₹ 1000-₹ 850= ₹ 150), however by virtue of section 94(7), only ₹ 50 (₹ 150-₹ 100) would be available as loss for set off and carry forward purposes as per old provisions.

In my opinion, since the shareholder would be paying tax on dividend received ₹ 100, he would also be allowed to claim the entire capital loss ₹ 150 (₹ 1000- ₹ 850) instead of capital loss to the extent of dividend amount in the earlier provision

Note:

Section 94 covers holding of securities or units both as capital assets and as stock-in-trade and hence section 94(7) would be applicable to both an investor as well as a trader of securities or units.

2. Bonus stripping refers to the practice of buying stocks or mutual fund units to take part in a bonus issue, which allows them to book losses on the original investment value and then set it off.

Section 94(8)

As per sec. 94(8), where-

a)     Any person buys or acquires any units within a period of three months prior to record date;

b)     Such person is allotted additional units without any payment on the basis of holding of such units on such date;

(c)   Such person sells or transfers all or any of the units referred to in clause(a) within a period of 9 months after such date, while continuing to hold all or any of the additional units referred to in clause (b),

then, the loss, if any, arising to him on account of such purchase and sale of all or any of such units shall be ignored for the purposes of computing his income chargeable to tax and notwithstanding anything contained in any other provision of this Act, the amount of loss so ignored shall be deemed to be the cost of purchase or acquisition of such additional units referred to in clause (b) as are held by him on the date of such sale or transfer.

Analysis:-

 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).

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 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.

Example 1:

A Mutual fund declares 1:1 bonus units on its unit on 30.04.2020.Record date for bonus to be 31.05.2020. Mr. B purchase 1000 units on 20.05.2020 @ ₹ 20 per unit and sells 1000 units on 11.11.2020 for ₹ 9 per units.

Period of holding- 20.05.2020 to 10.11.2020-  Short Term

Sale Price- ₹ 9*100      = ₹ 9, 000

Cost of Acqs- ₹ 20*100= ₹ 20, 000

STCL on sale    = ₹ 11,000

As per sec 94(8), the short term capital loss of ₹ 11, 000 shall be ignored for the purposes of computing the total income and such STCL of ₹ 11, 000 shall neither be set-off nor be carried forward.

COA of 1000 bonus units shall be taken as ₹ 11,000 i.e. ₹ 11 per unit.

Example 2

 You invest in Company A ₹ 100000 (100 shares @ ₹ 1000 per share) and It declares bonus in the ratio of a 1:1.

After the record date you get 100 shares as bonus and thus you will have 200 shares.

 – First 100 shares sold at ₹ 550 within one year from date of purchase and rest 100 shares sold after 1 year from the date of allotment of bonus shares (please note that in case of bonus shares 1 year is calculated from the date of allotment and not purchase of original shares)

This arrangement will lead to savings in tax.

The calculation will be as follows.

a) On shares bought – Short term Capital loss (₹ 550 – ₹ 1000) X 100 shares = Rs (45,000)

Since the bonus shares will be sold after 1 year, hence no tax would need to be paid on the same.

This loss of ₹ 45,000 can be set off against the other short term capital gains during the year. It thus leads to a saving of 15% of ₹ 45,000 = ₹ 6750 on the tax outgo front.

Please note that this scheme works only if the bonus shares are held for a period of more than one year from the date of allotment.

1. Is Bonus striping still possible ?

Yes

• Used when- assessee having a STCG due to selling of mutual fund and stock.
• Cut tax on STCG/LTCG  by bonus stripping
• Notional loss by bonus stripping can be adjusted against any other STCG or LTCG from other sources.

The contents of this article are solely for information purpose only.

Author can be reached at

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Discussions to this article

[Sharad Shukla]

As rightly pointed out by author that all three conditions of 94(7) need to be fulfilled since now dividend is taxable , third condition 94(7) is not being fulfilled hence one can claim short term capital loss . This entire section is now null and void. It appears that tax deptt has inadvertently missed to amend this section in light of 2020 tax amendment by bringing dividend under taxation net.