CAN THE INVESTOR STRIP???
Aditya KhemkaManagement Development Institute, Gurgaon
Previously, dividends were taxed but then came in the arguments against doubletaxation of corporate profits. The point put forward was that first the corporate profits aretaxed by way of income tax. Then the profits are appropriated by the corporate to paydividend and then the dividend was being taxed by way of a dividend tax. Thus, the sameamount of money was taxed twice and the investors were the losers. So, the governmentdecided to lift the dividend tax and opened a loop hole for the INTELLIGENT Indianinvestors.Thus started a process called
Dividend Stripping
. The investor is supposed topay capital gains tax on the shares he sells for a profit. Because of the short term beliefsheld by most of the investors the capital gain is mostly short term that is less than oneyear has expired between the purchase and sell of the shares in this case. The short termcapital gains can be set off by short term capital losses made in the same context. So if aninvestor could make a loss without actually suffering it, he would evade the capital gainstax.In order to do so, investors started purchasing shares which had a proposeddividend. As soon as the dividend is declared the share prices shoot up approximately bythe amount of the dividend. Then when the stock goes ex dividend the prices fall by thesame amount and the investor sold the stock at that price which was lower than thepurchase price.Note that the difference between the two had already been received by theinvestor in terms of dividend. So he accrued a short term capital loss in the books of accounts without having to suffer any loss actually. Thus, he successfully strips himself of the profit by taking untaxed dividend.
96979899100101102103104105106
9 / 1 / 2 0 0 4 9 / 2 / 2 0 0 4 9 / 3 / 2 0 0 4 9 / 4 / 2 0 0 4 9 / 5 / 2 0 0 4 9 / 6 / 2 0 0 4 9 / 7 / 2 0 0 4 9 / 8 / 2 0 0 4 9 / 9 / 2 0 0 4 9 / 1 0 / 2 0 0 4 9 / 1 1 / 2 0 0 4 9 / 1 2 / 2 0 0 4 9 / 1 3 / 2 0 0 4 9 / 1 4 / 2 0 0 4 9 / 1 5 / 2 0 0 4 9 / 1 6 / 2 0 0 4 9 / 1 7 / 2 0 0 4
In the above example, the dividend is declared on 1
st
, the investors buys the stock on the 2
nd
at Rs.104 and sells the same on 12
th
for Rs.100 while also receiving a dividendof Rs.5 at the same date. Thus he ends up with a capital loss of Rs.4 per share withoutactually suffering any loss at all and thus evades tax on profit made on other investments.But, the above example is of no use today. Since the dividend tax has beenreinstated dividend stripping is of no use because the investor has to pay tax on dividendif he evades tax on capital gains. But we are INTELLIGENT investors, so there isanother way. This is
Bonus stripping
.When a corporate decides to issue a bonus share the price of the share fallsproportionately. Thus similar to the case of dividends cited above, when a bonus isdeclared the share prices of the company do rise a little if it meets the marketexpectations. However, unlike the case of dividends it is not always true. The share pricesmay remain unaffected or even fall after a bonus is declared.
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