For instance, assume that a person buys a share at Rs 108, and that the company declares a dividend of Rs 2 (for which dividend is exempt) and the share price, post dividend, falls to Rs 106 per share. The assessee, in such a case, achieves two benefits. Firstly, he receives the tax-free dividend of Rs 2 and at the same time he has short-term capital loss of Rs 2 which can be set-off against other capital gains.
But the above route of tax avoidance is now plugged with effect from assessment year 2002-03 by virtue of the insertion of sub-section (7) in section 94 of the Income-tax Act, 1961 (the Act). Section 94 generally deals with the avoidance of tax by certain transactions in securities. The new sub-section (7) which was inserted by the Finance Act, 2001 with effect from assessment year 2002-03 states that 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 such securities or unit within a period of three months after such date;
(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.
In order to attract the provisions of sub-section (7) of section 94, all three conditions listed above are required to be satisfied. Even if one of its said conditions is not satisfied, the provisions of section 94(7) cannot be resorted to by the Department.
The term securities has been explained to include stocks and shares. And the term unit means the unit of a mutual fund specified under section 10(23D) of the Act and includes units of the Unit Trust of India. Record date has been defined as such date as may be fixed by the company or mutual fund or Unit Trust of India for the purposes of entitlement of the holder of the securities or the unit holder, to receive dividend or income, as the case may be.
From the above, it will be evident that if the record date is, say, July 31, 2003, then a transaction of purchase on or after April 30, 2003 would get hit by the provisions of section 94(7) if the said purchased share or unit is sold on or before October 31, 2003. In such an event, to the extent of dividend from the company or income distributed of the mutual fund the benefit of loss on sale will not be available. However, if the loss exceeds the extent of the dividend which is exempt from tax, then such excess loss would be available as a short-term capital loss for set-off against other capital gains and/or for carrying forward of the said loss as the case may be.
However, as per newspaper reports, the Income-tax Department is, unfortunately, taking the view that, even prior to assessment year 2002-03, such transactions will not enable the assessee to keep the benefits of dividend stripping.
The Department is holding that everybody involved in a transaction of dividend stripping benefits except the exchequer. It seems from these reports that if the motive for the original purchase of units is quick profits and not investment, then the benefit of the short-term loss would not be available. This may be true in case it is held that the transactions in the securities are in the nature of a business transaction. But then the benefit of claiming a business loss from the shares sold would be available to the assessee.
It is a question of fact whether dividend stripping could be perceived as being in the nature of a business transaction or whether it would remain in the realm of an investment transaction, resulting in a capital loss. In any event, the loss would be available prior to the assessment year 2002-03, either as a business loss or as a short-term capital loss.
Though the Department is brushing aside the implication of the insertion of sub-section (7) in section 94 with effect from assessment year 2002-03, this cannot be done so very easily. The reasons for the insertion of sub-section (7) can be gleaned from the Explanatory Memorandum to the Finance Bill 2001 and there is no hint in the Explanatory Memorandum that this is a clarificatory amendment and that it is retrospective. Therefore, the amendment should be considered as prospective in nature applying only from the date of amendment, viz., from assessment year 2002-03.
Whatever may be the position prior to assessment year 2002-03, it is now clear that from assessment year 2002-03 onwards such dividend stripping will not give any extra benefit to the assessee. But, unfortunately, if the view canvassed by the Department regarding obtaining quick profits is to be used to whip the assessee then even a holding in excess of the statutory period under section 94(7) could be brushed aside by the Department. That is not the intention of the Act and one hopes that the Department will not be so short sighted and narrow minded in its view.
The author is a Chartered Accountant