Dividend Stripping and Tax Liability

Dividend stripping was a strategy to reduce the tax burden, by which an investor gets dividend which is tax free, by investing in shares/ mutual fund units, just before the declaration of dividend and then selling it off right after the receipt of dividend 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 whether short-term or long-term. The balance amount of loss will be set off in next year under the same head of income.

The dividend stripping creates a great loss to the government in respect of taxes. However, 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)] and, on the other side, he would suffer a short-term capital loss which is available to be utilized or carry forward for next assessment years to reduce tax liability.

Example-

Mr. X earns dividend of Rs. 1,00,000 (i.e. 2000 shares @ 50/- per share) and earns capital loss of Rs. 1,10,000 [i.e. 2000 shares @ 55/- (200–145= 55)].

Mr. X earns Rs. 1,00,000 as dividend  which is exempt from Tax and also earns short term capital loss of Rs. 1,10,000 which will be set off against capital gains income and also save tax on that income. This is called dividend stripping. The government suffers a loss of income tax on dividend income and also on short term capital loss which will be set off against capital gains.

The New Section 94(7) was introduced to evoke this type of dividend stripping which incurs a great loss to the government. Under this scheme capital loss will not be allowed for set off to the extent of dividend earned or under capital gain it will be taxable under “Income from Other Sources”. Dividend is exempted under section 10 (34).

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.

Situation1. If securities purchased within a period of 3 months of the record date or sold within a period of 3 months after the record date

Example 1-

Answer-

Mr. X earns dividend of Rs. 1,00,000 (i.e. 2000 shares @ 50/- per share) and earns capital loss of Rs. 1,10,000 [i.e. 2000 shares @ 55/- (200–145= 55)].

After applicability of this section 94 (7), Mr. X will be allowed to set off loss of Rs. 10,000 (i.e. Capital loss of Rs. 1,10,000 – Dividend Income Rs. 1,00,000), because securities purchased within a period of 3 months and also sold within 3 months of record date (i.e. 31.03.2018)

Situation2. If securities purchase before a period of three months of the record date or sold within a period of three months after the record date.

Example 2-

Answer-

Mr. X earns dividend of Rs. 1,00,000 (i.e. 2000 shares @ 50/- per share) and earns capital loss of Rs. 1,10,000 [i.e. 2000 shares @ 55/- (200–145= 55)].

applicability of this section 94 (7), Mr. X will be allowed to set off loss of Rs. 10,000 (i.e. Capital loss of Rs. 1,10,000 – Dividend Income Rs. 1,00,000), because securities purchased before a period of 3 months but sold within 3 months of record date (i.e. 31.03.2018).

Situation3. If securities purchased within a period of three months of the record date or sold after three months of the record date.

Example 3-

Answer-

Mr. X earns dividend of Rs. 1,00,000 (i.e. 2000 shares @ 50/- per share) and earns capital loss of Rs. 1,10,000 [i.e. 2000 shares @ 55/- (200–145= 55)].

After applicability of this section 94 (7), Mr. X will be allowed to set off loss of Rs. 10,000 (i.e. Capital loss of Rs. 1,10,000 – Dividend Income Rs. 1,00,000), because securities purchased within a period of 3 months but sold after 3 months of record date (i.e. 31.03.2018)

Situation4. If securities purchased within a period of three months of the record date or sold after three months of the record date.

Example 4-

Answer-

Mr. X earns dividend of Rs. 1,00,000 (i.e. 2000 shares @ 50/- per share) and earns capital loss of Rs. 1,10,000 [i.e. 2000 shares @ 55/- (200–145= 55)].

After applicability of this section 94 (7), Mr. X will be allowed to set off loss of Rs. 50,000, because securities purchased before 3 months and sold after 3 months of record date (i.e. 31.03.2018).