Dividend Stripping and Bonus Stripping

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A. 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 provisions of Dividend Stripping

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 Conditions Securities Units

Buying or acquiring Within a period of 3 Within a period of 3

months prior to the record months prior to the record
date date

Selling or transferring Within a period of 3 Within a period of 9

months after the record months after the record
date date

Dividend or income Exempt Exempt

during intervening
period

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

♣ Consequence if conditions related to Dividend Stripping 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.

♣ Practical Example on Dividend Stripping

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. Particulars Calculation in different cases (Amount in Rs.)

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 7000 shares (SP – Rs. 3000 shares (SP –Rs.
35) 25)
Sold on 28.09.2017 Sold on 18.12.2017

A Sales Value 2,45,000 75,000

B Cost of Acquisition 3,50,000 1,50,000

C Short Term Capital Loss 1,05,000 75,000

(A-B)

D Dividend received 35,000 15,000

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.

B. 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 provisions of Bonus Stripping

Conditions Units*

Bought or acquired (Original units) Within a period of 3 months prior to the

record date

Allotment of additional units (Bonus Without any payment on such record date
units)

Sold or transferred (Original units) Within 9 months after the record date

Holds atleast one additional bonus On the date of such sale or transfer of
unit original units

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

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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.

♣ Practical Example on Bonus Stripping

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.)

A Sales value (10000 x 35) 3,50,000

B Cost of acquisition (10000 x 50) 5,00,000

C Short term capital Loss (A-B) 1,50,000

D No. of bonus units 10,000

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. Particulars Calculation (Amount in Rs.)

Original units Bonus units

(10,000) (7,000)

A Sales value 3,50,000 2,45,000

B Cost of acquisition 5,00,000 1,05,000*

C Short term capital Loss/Gain (1,50,000) 1,40,000

(A-B)

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 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 = Rs. 1,05,000

10,000

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-

Particulars Calculation (Amount in Rs.)

Original units Bonus units

(10,000) (10,000)

A Sales value 3,50,000 3,50,000

B Cost of acquisition 5,00,000 NIL

C Short term capital Loss/Gain (A- (1,50,000) 3,50,000

B)

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.

C. Extract of Section Section 94 of the Income Tax Act, 1961

Avoidance of tax by certain transactions in securities.

94. (1) Where the owner of any securities (in this sub-section and in sub-section (2)
referred to as “the owner”) sells or transfers those securities, and buys back or reacquires
the securities, then, if the result of the transaction is that any interest becoming payable in
respect of the securities is receivable otherwise than by the owner, the interest payable
as aforesaid shall, whether it would or would not have been chargeable to income-tax
apart from the provisions of this sub-section, be deemed, for all the purposes of this Act,
to be the income of the owner and not to be the income of any other person.

Explanation.—The references in this sub-section to buying back or reacquiring the

securities shall be deemed to include references to buying or acquiring similar securities,
so, however, that where similar securities are bought or acquired, the owner shall be
under no greater liability to income-tax than he would have been under if the original
securities had been bought back or reacquired.

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(2) Where any person has had at any time during any previous year any beneficial
interest in any securities, and the result of any transaction relating to such securities or
the income thereof is that, in respect of such securities within such year, either no income
is received by him or the income received by him is less than the sum to which the
income would have amounted if the income from such securities had accrued from day to
day and been apportioned accordingly, then the income from such securities for such
year shall be deemed to be the income of such person.

(3) The provisions of sub-section (1) or sub-section (2) shall not apply if the owner, or the
person who has had a beneficial interest in the securities, as the case may be, proves to
the satisfaction of the Assessing Officer—

(a) that there has been no avoidance of income-tax, or

(b) that the avoidance of income-tax was exceptional and not systematic and that there
was not in his case in any of the three preceding years any avoidance of income-tax by a
transaction of the nature referred to in sub-section (1) or sub-section (2).

(4) Where any person carrying on a business which consists wholly or partly in dealing in
securities, buys or acquires any securities and sells back or retransfers the securities,
then, if the result of the transaction is that interest becoming payable in respect of the
securities is receivable by him but is not deemed to be his income by reason of the
provisions contained in sub-section (1), no account shall be taken of the transaction in
computing for any of the purposes of this Act the profits arising from or loss sustained in
the business.

(5) Sub-section (4) shall have effect, subject to any necessary modifications, as if
references to selling back or retransferring the securities included references to selling or
transferring similar securities.

(6) The Assessing Officer may, by notice in writing, require any person to furnish him
within such time as he may direct (not being less than twenty-eight days), in respect of all
securities of which such person was the owner or in which he had a beneficial interest at
any time during the period specified in the notice, such particulars as he considers
necessary for the purposes of this section and for the purpose of discovering whether
income-tax has been borne in respect of the interest on all those securities.

(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;

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(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.

(8) Where—

(a) any person buys or acquires any units within a period of three months prior to the
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 nine 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.

Explanation.—For the purposes of this section,—

(a) “interest” includes a dividend ;

(aa) “record date” means such date as may be fixed by—

(i) a company for the purposes of entitlement of the holder of the securities to receive
dividend; or

(ii) a Mutual Fund or the Administrator of the specified undertaking or the specified
company as referred to in the Explanation to clause (35) of section 10, for the purposes of
entitlement of the holder of the units to receive income, or additional unit without any
consideration, as the case may be;

(b) “securities” includes stocks and shares ;

(c) securities shall be deemed to be similar if they entitle their holders to the same rights
against the same persons as to capital and interest and the same remedies for the
enforcement of those rights, notwithstanding any difference in the total nominal amounts
of the respective securities or in the form in which they are held or in the manner in which
they can be transferred;

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 (d) “unit” shall have the meaning assigned to it in clause (b) of the Explanation to section
115AB.

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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