Bonus stripping is another similar strategy of buying a fund’s units with the intention of earning bonus units and then selling original units at discounted prices.
By Chirag Nangia
To tackle tax avoidance, improve coherence of tax rules and ensure a more transparent tax environment, governments around the world have incorporated the General Anti-Avoidance Regulations (GAAR) into their respective national tax codes and also strengthened their existing codes through Specific Anti-Avoidance Rules (SAAR).
SAAR in case of bonus stripping, dividend stripping
One of the key SAAR provisions is contained in Section 94 of the Income Tax Act, which deals with transactions in mutual fund securities and units, including dividend stripping and bonus stripping.
The dividend stripping strategy was largely used to reduce the tax burden whereby an investor would invest in securities (including units) shortly before the record date, i.e. the date on which the dividend is declared, and sell at a lower price after the record date, causing a capital loss on short-term. This short-term capital loss would in any case be compensated by the tax-free dividend under the former dividend tax regime.
To preclude such an arrangement, Section 94(7) provides that any loss arising from such purchase and sale of securities or units, to the extent such loss does not exceed the amount of exempted dividends or income received on such securities or units is disregarded in the calculation of taxable income. It is relevant that this provision will continue to exist even after the promulgation of a new dividend tax regime in which dividends are taxable in the hands of shareholders.
Bonus stripping is another similar strategy of buying a fund’s units with the intention of earning bonus units and then selling original units at discounted prices. To put an end to the practice of bonus stripping, Section 94(8) states that loss, if incurred, may not be claimed in the calculation of income when units are sold within a nine-month period.
Currently, stripping bonuses for securities, units of Infrastructure Investment Trust (InvIT) or Real Estate Investment Trust (REIT) or Alternative Investment Funds (AIFs) is not within the scope of Section 94. Dividend stripping provisions also do not apply to the units of new pooled investment vehicles such as InvIT or REIT or AIFs. However, the Finance Bill 2022 proposes to make certain amendments to subject the previous anti-circumvention provisions of Section 94.
Interplay between GAAR and SAAR
Indian tax law has always had SAAR. These rules are aimed at specific ‘known’ constructions of tax avoidance. More recently, GAAR provisions have been incorporated into Chapter XA of the Act and have been declared applicable as of April 1, 2017. These provisions have a knock-on effect on the rest of the Act and give tax authorities unfettered powers to question transactions and arrangements. .
The Finance Bill 2022 proposal to broaden the scope of Section 94(7)/(8) makes one think about the need for such a specific provision when the GAAR is now in effect.
The Central Council for Direct Taxation (CBDT) has clarified the provisions of GAAR and SAAR will coexist and apply, if necessary, based on the circumstances of the case. While it has clarified that GAAR and SAAR will operate concurrently, several courts have ruled that specific provisions take precedence over the general provisions. Therefore, the courts may consider GAAR and SAAR as mutually exclusive, in light of the factual matrix of a case.
The writer is director, Nangia Andersen India. Input from Paridhi Sen.
This post Tax Talk: Should We Revise Dividend, Bonus Strip Provisions? was original published at “https://www.financialexpress.com/money/income-tax/tax-talk-do-we-need-to-review-dividend-bonus-stripping-provisions/2462035/”