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Income tax

ritesh (ca -ipcc) (61 Points)

17 August 2011

hiii all.....i would like to know about the practice of dividend stripping and bonus stripping????????.........

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5 Replies

urvi jitendra bhavsar (CA Final Student) (116 Points)
Replied 18 August 2011

can understand ur query???

plz explain........................

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CA Poonam Agrawal (Exchange of Knowledge) (91 Points)
Replied 18 August 2011

Dividend stripping is the purchase of shares just before a dividend is paid, and the sale of those shares after that payment, i.e. when they go ex-dividend.

This may be done either by an ordinary investor as an investment strategy, or by a company's owners or associates as a tax avoidancestrategy.

For an investor dividend stripping provides dividend income, and a capital loss when the shares fall in value (in normal circumstances) on going ex-dividend. This may be profitable if the income is greater than the loss, or if the tax treatment of the two gives an advantage.

Different tax circumstances of different investors is a factor. A tax advantage available to everyone would be expected to show up in the ex-dividend price fall. But an advantage available only to a limited set of investors might not.

In any case the amount of profit on such a transaction is usually small, meaning that it may not be worthwhile after brokerage fees, the risk of holding shares overnight, the market spread, or possible slippage if the market lacks liquidity.

Bonus stripping:

This tax planning is designed based on a loop hole in sec. 94(8) of Income tax Act.

Provision: 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 original 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)(i.e., Bonus units), 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 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.

On close observation of the above provision it is clear that it applies only in case of units and not for shares (or) securities. So the plan of action is as follows:

1. See the companies which are going to issue bonus shares.

2. Purchase the shares of those companies before the date of bonus issue

3. You will get Bonus shares.

4. After declaring bonus shares usually the price of share in the market will decrease ( Of-course the wealth of the shareholder wont change ). so, Sell the original shares (but not bonus shares) after the company declares bonus issue.

5. You will report a short term loss which can be set-off against capital gains.

6. After one year from the date of allotment of bonus shares sell them through a recognized stoc