Are Dividend Stripping and Bonus Stripping Provisions Really Necessary?

The existing dividend stripping provisions were introduced at a time when dividends in the hands of investors were exempt from taxation, and the distributing companies were paying dividend distribution tax on them. Similarly, income distribution by MFs was then exempted. At the time, an investor could buy shares or units co-dividends, receive a discounted dividend, and then sell them ex-dividend, ostensibly for a short-term capital loss, resulting in a related discounted dividend or MF. was offset by. Income. Similarly, bonus stripping provisions were introduced when long-term capital gains (LTCG) on sale of listed equity shares and equity-oriented MF units were exempted. An investor can buy shares or units co-bonus, and sell them after a few days, when the price after adjusting for the bonus is lower, and claim the difference between the original price and the post-bonus sale price as one. I can do. Short-term capital loss, which can be adjusted against other capital gains. Bonus shares or units, the cost of which is to be taken as nil, shall be sold after one year when the LTCG on such sale was exempted. Bonus stripping provisions were restricted to transactions in units of MFs as bonus stripping in shares was subject to the uncertainty of stock prices.

Therefore, these provisions were like anti-tax avoidance provisions, designed to prevent shrewd taxpayers from claiming tax benefits from transactions that were commercially nearly income neutral, but taxed in a manner beneficial to investors. was imposed.

The situation is quite different now with dividend stripping and bonus stripping, as dividends and income from MFs are subject to tax as ordinary income, while LTCGs are subject to tax on sale of listed equity shares and units of equity-oriented MFs. at 10%. Hence these dividend-stripping and bonus-stripping provisions were not applicable to any transactions in the past few years, which are mainly applicable to transactions in tax-exempt securities.

Now there is a demand to give a new lease of life by expanding the scope of these provisions. Dividend stripping provisions will be applicable on exempted income from REITs and InvITs other than AIF. In the case of Category I and II AIFs, the income earned by the AIF is taxed on a pass-through basis, almost all of which is taxed. It is only the business profit that is taxable as income of the AIF, and which is exempt in the hands of the investor. So these provisions will primarily affect Category II or III AIFs, also those who do business. In addition, units of AIF are rarely bought and sold in the secondary market – most investors retain their AIF investments for a few years. Hence it will affect very few transactions. Furthermore, the distribution to the investor is actually a taxable income – it is just that the tax is to be discharged by the AIF instead of the investor.

In the case of REITs/InvITs, the discount distribution received by the investor is only that part of the REIT/InvIT’s income that represents dividends earned from Special Purpose Vehicles (SPVs) that have paid tax on their profits at general corporate tax. . The rate, not the discounted corporate tax rate, and the return or amortization of capital by them (which is not actually income but return of capital). In most cases, the tax-exempt component is a small portion of the distribution. If one looks at the distribution of four listed InvITs and three listed REITs, in six out of seven, the vast majority of income is taxable in the hands of investors – it is only in one REIT that it has a major share of income tax for investors. is free. Here also these provisions will be applicable to limited cases only.

Today, bonus stripping gives the best results in deferring tax liability. No reason has been given in the explanatory memorandum to extend the bonus stripping provisions to the shares. Wouldn’t it be better to just remove these provisions, especially when the usual anti-avoidance provisions now exist?

Gautam Nayak is a Partner at CNK & Associates LLP.