Budget 2022-23: All about bonus stripping and dividend stripping

The Budget, in many ways, has attempted to clarify the intended interpretation or bring parity or counter tax evasion. With this objective, investments in REITs and INvITs have been brought at par with other defined securities (shares/units of mutual fund) with respect to tax laws on bonus stripping and dividend stripping

What is Bonus stripping and Dividend stripping?

Dividend stripping is the practice of buying shares a short period before the dividend is declared (i.e., cum-dividend) and then selling the shares at ex-dividend. So, let’s say price of a share is ₹20 before the declaration of dividend (i.e., say ₹5 of dividend) and post dividend the price of the share is ₹15. By doing dividend stripping, an investor will purchase at ₹20 and sell the shares after the dividend to create a capital loss (to be utilised against capital gain), while commercially there is no loss to the investor (more specifically under dividend distribution tax regime).

Similarly, bonus stripping is the practice of buying securities a short period before the company declares bonus securities and then sell the original securities, while retaining the bonus securities. So let’s say price of a security before the bonus is ₹100 and after the bonus declaration of 1:1 the price becomes ₹50. The investor would then sell the original security at ₹50 and generate a capital loss of ₹50 to be off set against capital gains

What was the law till now?

The Income Tax law provided that with respect to dividend stripping, losses arising from purchase and sale of securities shall not be allowed to the extent of exempt income (earlier dividends were exempt in the hands of shareholders until April 1, 2020 for listed securities and units) when a person buys any securities or units three months prior to the record date and such person transfers (a) securities within three months after record date and (b) units within nine months after the record date. Given that dividends are now taxable on listed shares and units, the law would have limited applicability in majority cases.

With respect to bonus stripping, the law was applicable to units only (i.e., units of a mutual fund or a unit of Unit Trust of India). The law provided for that loss arising on purchase and sale of original units shall be ignored and become the cost of acquisition of bonus units in case where a person buys or acquires original units within three months from the record date and additional units are allotted to him without payment and such person sells all original units within nine months after the record date.

What are the new provisions?

With respect to dividend stripping, basic conditions remaining the same, the law is extended to also cover units of Real Estate Investment Trust (REITs) and Infrastructure Investment Trust (InvITs) and beneficial interest of an investor in an Alternative Investment Fund (AIFs), as per SEBI regulations.

With respect to bonus striping, the law was earlier only applicable to units of mutual funds or UTI. Basic conditions remaining the same, the law is now extended to cover shares and stock (listed or unlisted), units of RETIs & InvITs and units of AIFs.

How are investors impacted?

Dividends received by unitholders of REITs and InvITs are exempt from tax where the special purpose vehicle (which generates the income stream for investors) pays income tax under the old tax regime at a higher rate of 30 per cent (plus surcharge and cess). Further, unitholders of AIFs receiving income distributed by AIFs are exempted from tax in certain cases. Thus, there was a perceived tax planning avenue which has now been fixed by the proposed amendment.

Bonus stripping had very restricted applicability, however, with the new coverage most category of investments being shares and stock (listed or unlisted), units of REITs & InvITs and units of AIFs, will now get covered and investors will need to be mindful of the applicability of applicability of the provisions in aggressive transactions. However, generally REITs etc do not declare bonus and hence, to that extent applicability may be restricted.

Generally, the investors in these vehicles are stable long-term investors who wish to get sustainable fixed income as an alternate to interest or rent without taking any significant risk/exposure. As a result, such an amendment is not likely to generate any significant tax revenues nor impact such long-term investors. Thus, its more of a At Par provision to ensure that there is no disparity nor discrimination.

The writer is Partner, EY India

(Sapan Choksi, Senior Tax Professional, EY also contributed to the article)

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