Budget 2022 has plugged the loop hole on tax avoidance through bonus stripping and dividend stripping in the capital markets.

Listed stocks and mutual fund (MF) units have been covered under the amended provisions of bonus stripping and units of infrastructure investment trust (InvIT), real estate investment trust (REIT) and alternative investment Funds (AIFs) have been covered to stop dividend stripping, budget documents show.

Bonus stripping is a situation when purchase or sale of shares or MF is done in a manner, which would result in short-term capital loss that can be adjusted against capital gains.

Dividend stripping is where any units of funds are bought for a short period ahead of the dividend being declared, called cum-dividend, and then selling them when the units go ex-dividend. This way one is entitled to dividend without tax since units of InvIT, REIT and AIFs have been exempt from tax.

However, since the amended provisions will come into effect from April 2023, experts say this will create a frenzy for bonus and dividend announcements in the next couple of months.

The money earned through bonus stripping will be assessed under the income tax from 2022-2023.

“Some investors used to strip the instrument as a tool for tax planning. They would sell the original shares and book losses on allotment of bonus shares and thus reduce their overall capital gains tax for that year. Such investors will now have to re-plan their affairs. They will now be forced to postpone the claim of losses to the year when the bonus shares are transferred,” said Suresh Swamy, Partner, Price Waterhouse & Co LLP.

Section 94 of the Income Tax Act contains anti avoidance provisions to deal with transactions in securities and units of mutual funds. . However, this section did not apply to bonus stripping undertaken in case of securities and MF units and dividend stripping on units of InvIT, REIT, AIFs or pooled investments.