Filing for AY 2024-25 is coming soon
Filing for AY 2024-25 is coming soon
Keep calm and sign up for early access to our super filing platform

The concept of Dividend Stripping in India

Updated on: Jan 17th, 2024

|

5 min read

social iconssocial iconssocial iconssocial icons

Shareholders and mutual fund investors often receive dividends on their investments (based on their choices). These dividends are tax-free. And if there is a long-term capital gains (LTCG), only a concessional LTCG tax 10% applies on gains above Rs 1 lakh. In addition, losses under the head ‘Capital Gains’ can be set off against income from capital gains. But some smart investors resort to ‘Dividend Stripping’ to avail maximum tax benefits. Let us try and understand the concept of dividend stripping in detail and how our tax laws keep a check on such activities.

What is Dividend Stripping

Investors, in a bid to avail maximum tax benefits from an investment, buy shares/mutual fund units before the declaration of dividend, post the dividend declaration they sell the share/unit when its price falls below the purchase price. This practice is termed as dividend stripping.

As a result of this activity, the investor receives tax-free dividends. But since the sale made after receiving the dividend is done at a price lower than the purchase price, it results in a capital loss. You can adjust such losses against any other capital gains income. Hence, the taxpayer enjoys a twofold benefit i.e. earning an income that is totally exempt and claiming a capital loss that can reduce the total income of the individual.

Illustration

The concept of dividend stripping can be better explained by way of an example:

  • Company XYZ makes an announcement that it is going to pay a dividend of Rs. 50 on April 5, 2018;  
  • Rahul purchased the shares of this company on March 26, 2018, when the price was Rs.180. He purchased a total of 100 shares.
  • On April 5, 2018, he received a total dividend of Rs.5000.
  • The price of shares after dividend declaration fell to Rs. 150. Mr A sells the shares on May 20, 2018, and therefore makes a loss of Rs.3000.

Total benefit enjoyed by Mr A is thus Rs.8000 (exempt dividend income of Rs 5,000 and capital loss of Rs 3,000)

Income tax implications

Dividend stripping is not exactly illegal. However, it causes a loss to the exchequer. To address this, section 94 (7) of the Income-Tax Act was introduced. Generally, those shareholders, whose name is included in the register of the company as shareholders on the record date, are entitled to receive dividends declared by the company.

The provisions of income tax on dividend stripping are applicable when an investor, who buys securities within the 3 months prior to the record date and sells such securities, within 3 months after such date in case of shares and within 9 months in case of units. In such cases, the capital loss arising to the shareholder to the extent of such dividend income shall be ignored i.e. the loss would not be available for set off against capital gain income.

Example:

  • Mr A bought 1000 shares of B Co. Ltd. on Mar 2, 2018, for Rs.180/ share.
  • B Co. declared a dividend of Rs.40 that will be payable on Mar 31, 2018. So he earned an income of Rs.40,000.
  • On April 20, 2018, Mr A sold the shares of B Co. Ltd for Rs.120 per share. Thus he made a loss of Rs.60,000.
  • The dividend income is wholly exempt in his hands.
  • Of the short-term capital loss made of Rs. Rs.60,000, as per Section 94(7), Rs 40,000 would be disallowed and he can claim a loss only to the extent of Rs 20,000.

If in the above example, had Mr. A sold the shares at Rs 160, his capital loss would be lesser than the dividend received. And accordingly, no loss would be available for set off. On the other hand, if he makes a profit, his entire dividend will stand as exempted and the amount of capital gain will be subject to capital gains tax.

Advantages of Dividend Stripping for Investors:

  1. Utilization of Short-Term Capital Loss (STCL): Engaging in dividend stripping allows investors to offset Short-Term Capital Loss (STCL) incurred from the sale of shares or units against various capital gains, including both Short-Term Capital Gains (STCG) and Long-Term Capital Gains (LTCG). This strategy effectively minimizes the overall tax liability for the investor.
  2. Tax-Free Dividend Earnings: Through dividend stripping, investors can enjoy the benefit of earning tax-free dividends, further enhancing the attractiveness of this investment approach.

inline CTA
File your returns in just 3 minutes
100% pre-fill. No manual data entry
CONTENTS

Clear offers taxation & financial solutions to individuals, businesses, organizations & chartered accountants in India. Clear serves 1.5+ Million happy customers, 20000+ CAs & tax experts & 10000+ businesses across India.

Efiling Income Tax Returns(ITR) is made easy with Clear platform. Just upload your form 16, claim your deductions and get your acknowledgment number online. You can efile income tax return on your income from salary, house property, capital gains, business & profession and income from other sources. Further you can also file TDS returns, generate Form-16, use our Tax Calculator software, claim HRA, check refund status and generate rent receipts for Income Tax Filing.

CAs, experts and businesses can get GST ready with Clear GST software & certification course. Our GST Software helps CAs, tax experts & business to manage returns & invoices in an easy manner. Our Goods & Services Tax course includes tutorial videos, guides and expert assistance to help you in mastering Goods and Services Tax. Clear can also help you in getting your business registered for Goods & Services Tax Law.

Save taxes with Clear by investing in tax saving mutual funds (ELSS) online. Our experts suggest the best funds and you can get high returns by investing directly or through SIP. Download Black by ClearTax App to file returns from your mobile phone.

Cleartax is a product by Defmacro Software Pvt. Ltd.

Company PolicyTerms of use

ISO

ISO 27001

Data Center

SSL

SSL Certified Site

128-bit encryption