What is Dividend Stripping
Dividend stripping is the practice of buying
shares a short period before a dividend is declared, called cum-dividend, and then selling them when
they go ex-dividend, when the previous owner is entitled to the dividend.
Dividend stripping refers to transacting in shares or
securities linked to shares of a company on which dividend is payable. It is a devise adopted to legitimately avoid
payment of taxes on taxable income. Investors, in a bid to
avail maximum tax benefits from an investment, buy shares/mutual fund units
before the declaration of dividend, post the dividend declaration they sell the
share/unit when its price falls below the purchase price. This practice is
termed as dividend stripping. As a result of this activity, the investor
receives tax-free dividends. But since the sale made after receiving the
dividend is done at a price lower than the purchase price, it results in a
capital loss.
Dividend Stripping - Section 94(7)
|
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 Mutual Fund |
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 / Mutual Fund Units, shall be ignored to the
extent of dividend / income received or receivable thereon.
The concept of dividend stripping can also be
better explained by way of an Illustration :
·
Company XYZ makes an
announcement that it is going to pay a dividend of Rs. 50 40 on 05,04,2020;
·
Mr. ‘A’ purchased the
shares of this company on 27 03.2020, when the price was Rs. 200. He purchased
a total of 100 shares.
·
On 05.04.2020, he
received a total dividend of Rs. 4,000.
·
The price of shares
after dividend declaration fell to Rs. 170 150. Mr ‘A’ sells the shares on 18.05.2020, and therefore makes a loss of Rs. 3000.
· Total benefit enjoyed by Mr A is thus Rs. 7,000 (exempt
dividend income of Rs 4,000 and capital loss of Rs 3,000)
With a view to disallow such losses, the Finance Act, 2001 inserted Sub-Section (7) in Section 94 with effect from 01.04.2002.
Inserted Sub section (7) in Section
94 vide Finance Act, 2001 with effect from 01.04.2002
The Finance Act, 2001 in order to curb the
practice of dividend stripping, amended section 94.
Sub-section (7) has been inserted in section 94, which provides that where any
person buys or acquires any securities or units within a period of three months
prior to the record date fixed for entitlement to receive dividend or income which is
exempt and he sells or transfers such securities or units within a period of
three months after such date, the loss to the extent of dividend or income shall be
ignored for the purpose of computing the income chargeable to tax. Thus, the
short-term capital loss will not be considered at all and would not be
available for set-off.
In the Memorandum explaining the
provisions of the Finance Bill, it has been stated that, "It has been
pointed out that the purchase and resale of securities, including units of
equity-oriented mutual funds, is being carried on for the purpose of creating
short-term losses. These losses are set off against other incomes and, thus, an
unintended benefit flows to the taxpayer. This practice popularly known as dividend stripping is being widely
used to reduce the tax which would have been otherwise payable by the
taxpayers."
Thus, the Finance Bill clearly proposes to put
an end to the practice of dividend stripping. This amendment is,
however, proposed to be made effective from the assessment year 2002-03.
Text of section 94(7)
Where–
(a) any
person buys or acquires any security 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
exempted,
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.
Conditions for
applicability of Section 94(7)
From a reading
of section 94(7), it comes into play, only when all the following three
conditions are satisfied :
(a) Assessee should buy securities or units within
a period of three months, prior to the record date;
(b) Should
sell or transfer such securities within a period of three months from the
record date or in cases of units within a period of nine months from
the record date; and
(c) Dividend or income on such securities or
units is exempt from tax. The wording 'then' occurring in the section makes
it clear.
When all these
three conditions are cumulatively satisfied, then only
the loss, if any, arising on account of such purchase and sale of
securities/units would not be allowed to the extent of dividend income.
Thus, all the three conditions must
be satisfied before section 94(7) is attracted. 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.
Applicability of provisions of income tax on dividend stripping
The provisions of income tax on dividend stripping are
applicable when an investor, who buys securities within the 3 months prior to
the record date and sells such securities, within 3 months after such date in
case of shares and within 9 months in case of units. In such cases, the capital
loss arising to the shareholder to the extent of such dividend income shall be
ignored i.e. the loss would not be available for set off against capital gain
income.
ILLUSTRATION
·
Mr A bought 1000 shares
of XYZ Ltd. on 10.03.2020, for Rs. 180/
share.
·
XYZ Ltd. declared a dividend of Rs. 40 that will
be payable on 31.03.2020. So he earned an income of Rs. 40,000.
·
On 15.04.2020, Mr A sold
the shares of XYZ Ltd. for Rs. 120 per
share. Thus he made a loss of Rs. 60,000.
·
The dividend income is
wholly exempt in his hands.
·
Of the short-term
capital loss made of Rs. Rs. 60,000, as per Section 94(7), Rs 40,000 would be
disallowed and he can claim a loss only to the extent of Rs 20,000.
If in the above example, had Mr. A sold the shares at Rs 160,
his capital loss would be lesser than the dividend received. And accordingly,
no loss would be available for set off. On the other hand, if he makes a
profit, his entire dividend will stand as exempted and the amount of capital
gain will be subject to capital gains tax.
Minimum holding period of securities or units
The provisions of section 94(7) provides for a minimum
holding period of securities or units after its purchase and before its sale.
The holding period is determined with reference to the record date. Record date
has been defined for the purpose of the aforesaid provisions to be “record date”
means such date as may be fixed by a company/mutual fund for the purposes of
entitlement of the holder of the securities/units to receive dividend. The minimum
holding period from the date of purchase till the record date is 3 months. The
minimum holding period after the record date before the units can be sold is 9
months.
Under section 94, the legislature has deliberately used different words ‘securities’ and ‘units’. The word ‘securities’ is referred to in section 94(7)(b)(i) and the word ‘unit’ is referred to in section 94(7)(b)(ii). Different period of minimum holdings for securities and the units have been provided under section 94(7)(b)(i) and (ii) respectively. Consequently, it is not open to read the word 'securities' as also including units.
Mutual fund units to be governed by section 94(7)(b)(ii)
The Parliament has not only used two different terms namely ‘securities’
and ‘units’ in section 94(7)(b)(i) and 94(7)(b)(ii) but has dealt with them
separately providing different minimum periods of holding for ‘securities’ and ‘units’.
It is settled position in law that
Parliament would not have used words in vain and a construction which renders
redundant any part of the statute must be avoided. Therefore, units would be
governed by the provisions in respect thereof in section 94(7)(b)(ii)
Where assessee purchased certain units of mutual funds and earned dividend of certain amount on same and soon after earning dividend, a redemption was taken place wherin assessee had suffered loss, since assessee filed several documentary evidences to prove genuineness of loss suffered by it on sale of mutual funds and, further, revenue admittedly found that subjected transaction completely falls out of clutches of section 94(7), assessee was entitled to claim set off of said loss against income from long-term capital gain
Securities - Avoidance of tax by certain transactions - During
year, assessee company had taken loan of Rs. 50 crore from IIFL. Out of loan
amount, assessee purchased certain units of mutual funds of Rs. 50 crore from
JMF-MF and earned dividend of certain amount on same - Soon after earning
dividend, a redemption was taken place wherein assessee had suffered loss of
Rs. 24.04 crores. This loss was set off against capital gain earned by assessee
during year from sale of immovable property. Assessee had also claimed dividend
income to be exempt under section 10(33). Assessing Officer observed that
assessee had concocted a story in connivance with JMF-MF and IIFL and attempted
to prepare a colorable device just to set off capital gain earned on sale of
immovable property and also by claiming exemption on dividend earned. It was
noted that loan taken by assessee from IIFL was paid through bank and that
assessee had also filed repayment schedule of IIFL-Assessee had also filed copy
of statement issued by JMF-MF in which purchase of mutual fund was clearly
shown. In view of documentary evidence, it was found that lower authorities
completely failed to rebut evidences and explanations so filed by agencies so
as to conclude that it was a colorable device or any connivance with companies
to evade tax by booking loss. Further, there was no loss to revenue insofar as
JMF-MF had already paid dividend distribution tax on declaration of such
dividend. There apart, assessee had also paid STT on these transactions as
evident from statement of JMF-MF on subjected transaction. There was no iota of
evidence brought by revenue on record to prove IIFL had indulged in providing
bogus capital gain/losses etc. Further, authorities below had admittedly found,
that subjected transaction completely falls out of Clutches of Section 94(7) i.e. restrictions Placed by legislature, thus,
claims made by assessee could not be denied. On facts, disallowance of assessee’s
genuine claim of loss incurred on redemption of mutual funds was unjustified. [In
favour of assessee] (Related Assessment year : 2015-16) - [Agencies
Rajasthan (P) Ltd. v. ITO (2019) 179 ITD 90 : 109 taxmann.com 139 : 73
ITR(T). 633 (ITAT Jaipur)]
Where assessee purchased units on 26.12.2003, which was record date, and sold same on 26.03.2004, period of three months reckoned from date of purchase of units would expire on 26.03.2004 and, therefore, provisions of section 94(7) were fully applicable to instant transaction
Assessee purchased units on 26.12.2003, which was record date.
He sold said units on 26.03.2004 and incurred short-term capital loss thereon. He
claimed said loss to be set off against short-term capital gain. Assessing
Officer disallowed claim of assessee on plea that transaction was hit by
provisions of section 94(7). Period of three months reckoned from date of
purchase of units would expire on 26.03.2004. Therefore, provisions of section 94(7) were fully applicable to transaction of sale of
units. [In favour of revenue] (Related Assessment year : 2004-05) - [Lachhmi
Narain Gupta & Sons v. CIT, Bathinda (2013) 263 CTR 615 : (2014)
221 Taxman 356 : 42 taxmann.com 27 (P&H)]
When there are two record dates between date of purchase and sale of units, first record date should alone be considered for applicability of provisions of section 94(7)
Dividend stripping - When there are two record dates between
date of purchase and sale of units, first record date should alone be
considered for applicability of provisions of section 94(7). Assessee purchased certain units of Birla
Dividend Fund on 15.09.2005 at a purchase price of Rs. 13.07 per unit. On these
units, on 28.10.2005 a dividend of Rs. 0.80 per unit was declared and on 13.01.2006
another dividend of Rs. 1.20 per unit was declared. Later on 14.02.2006
assessee had sold said units at rate of Rs. 12.38 per unit resulting in loss of
Rs. 26.39 lakhs. In return of income for assessment year 2006-07, assessee
claimed said loss as short-term capital loss. Assessing Officer held above
transaction involving purchase and redemption of units to be a dividend
stripping transaction covered by section 94(7) and accordingly disallowed claim of assessee for
deduction of loss on sale of units. He adopted 28.10.2005 as record date for
purpose of ascertaining applicability of section 94(7). Assessing Officer was justified in his action. [In
favour of revenue] (Related Assessment year : 2006-07) – [Smt.
Rohini Nilekani v. Addl. CIT (2014) 165 TTJ 929 : 149 ITD 183 (2013) 35
taxmann.com 536 (ITAT Bangalore)]
Units of a mutual fund are governed by provisions of section 94(7)(b)(ii)
Units of a mutual fund are governed by provisions of section 94(7)(b)(ii).
Therefore, where assessee sold units of mutual fund without holding them for a
period of nine months from record date, in view of amendment made to section 94(7)(b)(ii)
by Finance Act (No. 2) of 2004, loss arising on sale of said units was rightly
disallowed by authorities below. [In favour of revenue] (Related Assessment
year : 2005-06) - [Sista’s (P) Ltd. v. CIT (2013) 255 CTR 122 : (2012) 211
Taxman 244 : 27 taxmann.com 236 (Bom.]
Clauses (a), (b) and (c) of section 94(7) are to be cumulatively satisfied for attracting said provisions
A bare reading of the provision of section 94(7)
reflects that the three conditions mentioned in section 94(7)
are to be cumulatively satisfied for attracting the said provision. [In favour
of assessee] (Related Assessment year : 2004-05) – [CIT v. Kailash
Chandra Dhanuka (2012) 252 CTR 109 : 208 Taxman 97 19 taxmann.com
230 (MP)]
Where loss claimed by assessee on sale of shares was disallowed under section 94(7) and assessee could not give any reason for non-compliance with section 94(7), penalty levied under section 271(1)(c) was justified
Assessee-company engaged in business of sale and purchase of
shares claimed certain loss on sale of shares. Assessing Officer disallowed
amount for not complying with provisions of section 94(7)
and assessed it as income of assessee. Assessing Officer, thereafter imposed
penalty under section 271(1)(c). On appeal,
Commissioner (Appeals) deleted penalty but on appeal by revenue Tribunal
reversed order of Commissioner (Appeals). When assessee-company had been
availing services of a chartered accountant and in spite of that no reply was
filed by it for non-compliance with provisions of section 94(7)
while working out income shown in income-tax return, Explanation 1 to section 271(1)(c)
was directly applicable and penalty was rightly imposed by Assessing Officer. [In
favour of revenue] (Related Assessment year 2005-06) - [VSB
Investment (P) Ltd. v. CIT (2012) 212 Taxman 59 : 21 taxmann.com 162 (P&H)]
Section 94(7) dealing with dividend stripping is applicable from assessment year 2002-03 onwards and, therefore, Commissioner was wrong in invoking his revisionary power under section 263 on issue of dividend stripping, which related to assessment year 2001-02
Assessee had purchased units of mutual funds before record
date and sold them on next day. For relevant assessment year 2001-02, assessee
filed return claiming a loss on sale of units. Assessing Officer accepted
aforesaid transactions and allowed claim of assessee. Subsequently,
Commissioner having noticed that aforesaid transactions, which related to
dividend stripping, were accepted by Assessing Officer without verification,
took revisional proceedings against assessee. Since section 94(7)
dealing with dividend stripping became a part of statute with effect from 01.04.2002,
Commissioner was not justified in invoking his revisional power under section 263
on issue of dividend stripping. [In favour of assessee] (Related Assessment
year : 2001-02) – [CIT v. Leo Financial Services Ltd. (2012) 206 Taxman 144 : 21
taxmann.com 68 (Del.)]
Where assessee could not produce any details regarding short-term capital loss arising on sale of mutual fund units, disallowance under section 94(7) was justified
The assessee
had claimed short-term capital loss arising out of sale of units of mutual
funds which were held for a period of less than three months. The Assessing
Officer disallowed short-term capital loss to the extent of dividend receipt.
On appeal, the Commissioner (Appeals) confirmed the view of the Assessing
Officer since the assessee could not furnish details of the schemes for which
it had received dividend.
Held that it was
for the assessee to show that the short-term capital losses claimed by it were
all on mutual investments, for which there was no record date. The assessee
could not produce any details. In fact, nothing was brought on record to show
how the computation made by the Assessing Officer was not acceptable.
Therefore, the disallowance was rightly done.
[In favour of revenue] (Related Assessment
year : 2005-06) – [DCIT v. ABAN Offshore Ltd. (2012) 25 taxmann.com 441 : 13 ITR(T) 180 (ITAT Chennai)]
Whether by inserting section 94(7) with effect from 01.04.2002, Parliament has not
treated dividend stripping transactions as sham or bogus. By applying section 94(7) in a case for assessment year(s) falling after 01.04.2002,
loss to be ignored would be only to extent of dividend received and not entire
loss and, thus, losses over and above amount of dividend received would still
be allowed. – [CIT, Mumbai v. Walfort Share & Stock Brokers (P) Ltd.
(2010) 326 ITR 1 : 233 CTR 42 : 192 Taxman 211 (SC)]
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