Are dividend stripping and bonus stripping provisions actually required?

The latest funds proposes to increase the dividend stripping provisions to transactions in items of Real Estate Investment Trusts (REITs), Infrastructure Investment Trusts (InvITs) and Alternative Investment Funds (AIFs), from the prevailing applicability of transactions in securities and items of mutual funds (MFs). The bonus stripping provisions are actually being made relevant to all securities, together with shares, apart from transactions in items of REITs, InvITs and AIFs.

The current dividend stripping provisions had been launched at a time when dividends had been exempt from taxation within the fingers of traders, and the distributing corporations paying dividend distribution tax on them. Similarly, earnings distribution by MFs was then exempt. At that time of time, an investor may purchase the shares or items cum-dividend, obtain an exempt dividend, after which promote them ex-dividend, ostensibly incurring a short-term capital loss, which was offset by a corresponding exempt dividend or MF earnings. Similarly, bonus stripping provisions had been launched when long-term capital beneficial properties (LTCGs) on the sale of listed fairness shares and equity-oriented MF items had been exempt. An investor may purchase shares or items cum-bonus, and promote them after just a few days ex-bonus when the worth after adjusting for the bonus can be decrease, and declare the distinction between the unique worth and the post-bonus sale worth as a short-term capital loss, which could possibly be adjusted towards different capital beneficial properties. The bonus shares or items, whose value is to be taken as nil, would then be bought after a 12 months when the LTCGs on such sale had been exempt. The bonus stripping provisions had been restricted to transactions in items of MFs since bonus stripping in shares was topic to the vagaries of inventory costs.

These provisions had been, subsequently, like anti-tax avoidance provisions, designed to stop astute taxpayers from claiming tax advantages from transactions that had been commercially virtually earnings impartial, however taxed in a fashion advantageous to traders.

The place now could be fairly completely different with dividend stripping and bonus stripping now not engaging, since dividends and earnings from MFs are topic to tax as regular earnings, whereas LTCGs on the sale of listed fairness shares and items of equity-oriented MFs are topic to tax at 10%. These dividend-stripping and bonus-stripping provisions had been subsequently hardly relevant to any transactions during the last couple of years, being primarily relevant to transactions in tax-free securities.

A brand new lease of life is now being sought to be given to those provisions by extending the scope. Dividend stripping provisions would apply to exempt earnings from REITs and InvITs, apart from from AIFs. In the case of Category I and II AIFs, the earnings earned by the AIF is taxed on a pass-through foundation, virtually all of which is taxable. It is simply enterprise earnings which are taxable as earnings of the AIF, and that are exempt within the fingers of the investor. These provisions will subsequently impression primarily class II or III AIFs, that too these which keep on enterprise. Further, items of AIFs are not often purchased and bought within the secondary market – most traders maintain on to their AIF investments for just a few years. It will subsequently impression only a few transactions. Besides, the distribution to the investor can be a taxable earnings – it’s simply that the tax needs to be discharged by the AIF as an alternative of the investor.

In the case of REITs/InvITs, the exempt distribution acquired by the investor is simply that a part of the earnings of the REIT/InvIT which represents dividends earned from Special Purpose Vehicles (SPVs) which have paid tax on their earnings on the regular company tax charge, and never the concessional company tax charge, and the return or amortization of capital by these (which is admittedly not earnings however a return of capital). In most circumstances, the tax-free element is a small proportion of the distribution. If one seems to be on the distribution of the 4 listed InvITs and the three listed REITs, in six out of the seven, the overwhelming majority of earnings is earnings taxable in fingers of traders – it’s in solely in a single REIT that the key a part of the earnings is tax-free for traders. Here too, these provisions will apply solely to restricted circumstances.

Today, bonus stripping at finest leads to a deferral of tax legal responsibility. The explanatory memorandum doesn’t spell out any causes for extending the bonus stripping provisions to shares. Would it not have been higher to have simply deleted these provisions, notably when General Anti-Avoidance provisions now exist?

Gautam Nayak is accomplice, CNK & Associates LLP.

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