Dividend stripping finally banned

Dividend stripping finally banned
ENS ECONOMIC BUREAU

MUMBAI, MAR 1: Finance Minister Yashwant Sinha has finally curbed investors from taking advantage of dividend stripping by investing in mutual funds for the short term.

Budget 2001: Full Coverage

Dividend stripping was earlier possible under Section 94. But realising that this results in "unintended benefit flows to the taxpayer", the government intends to introduce a new Sub-section (7) in the above section. Dividend stripping involves getting in and out of equity-based schemes (since their dividend is tax free) in quick succession, whenever there is a reasonably liberal amount of dividend being declared by a mutual fund.

"If a person buys or acquires securities or unit within a period of three months prior to the record date fixed for declaration of dividend or distribution of income and sells or transfers the same within a period of three months after such record date, and the dividend or income received or receivable is exempt, then, the loss, if any, arising from such purchase or sale will be ignored to the extent such loss does not exceed the amount of such dividend or income, in the computation of the income, chargeable to tax, of such person," says the budget proposal. The finance ministry was expected to plug this loophole and they have done it.

According to sources, dividend stripping has led to a major revenue loss of around Rs 5,000 crore to the exchequer. It may be mentioned that some high networth individuals were making frequent sale and repurchase of mutual funds to avail the benefits of exemption of dividend tax. Several cases of dividend stripping became prominent following the exemption of dividend tax announced in the budget for 1999-2000.

This method of saving or rather evading tax is hardly new. Previously it used to be Unit Trust of India units under various schemes. Later even private sector mutual funds (MF) snared into this practice. Various stock exchange brokers have indulged in this practice with the connivance of top MF officials. It is only recently that it has caught investors' fancy.

The modus operandi followed by such "investors" is very simple. First, units of a MF that has declared dividend are purchased before the record date. These units are tendered for repurchase once the payment of dividend is made. If there is not any sharp movement in the markets (capital or debt), then the repurchase price would be the same as the sale price of the units less the amount of dividend per unit as well as exit load, if any.

All the parties involved in the transaction from the investors, brokers, mutual fund to the asset management company become beneficiaries of the game. The investor gets tax free dividend in his hand. At the same time he also gets the benefit of short term capital loss/ business loss (depending upon his normal business activity) on the differential amount between the sale and repurchase price.

If the investor is a company, then it can save a whopping 41 per cent of the amount of notional loss so incurred while an individual can save up to a maximum of 33 per cent. Therefore, the stakes are high for the investor to take such a decision. The other players are also adequately compensated. The broker gets commission from the MF, the AMC in turn earns portfolio management fees while the fund itself earns money by way of exit load which is charged for early exit from the scheme. The only loser in this transaction was the exchequer which lost a sizeable tax revenue.