Dividend Stripping is a process by which a investor gets tax free dividend by investing in securities (including units), shortly before the record date and exiting after the record date at a lower price, thereby incurring a short term capital loss. The short term capital loss is compensated with the tax free dividend. Further the investor can set off such loss against other capital gains and can also carry forward the unabsorbed loss for set off in future years.

It may be noted that dividend on shares is exempt under section 10(34) and dividend /income on units is exempt under section 10(35).

Applicability of sub-section (7) of section 94

The following three conditions have to be cumulatively satisfied in order to attract section 94(7) in case of securities:

• buying or acquiring any securities within a period of three months prior to the record date;
• selling or transferring such securities within a period of three months after the record date; and
• the dividend or income on such securities received or receivable by such person during the intervening period is exempt.

The following three conditions have to be cumulatively satisfied in order to attract section 94(7) in case of units:

• buying or acquiring any units within a period of three months prior to the record date;
• selling or transferring such units within a period of nine months after the record date; and
• the dividend or income on such units received or receivable by such person during the intervening period is exempt.

Hence, in the following situations section 94(7) will not apply:

Situation 1

• buy or acquire any securities or units before a period of three months prior to the record date;
• earn tax free dividend or income on such securities or unit during the intervening periods; and
• sell or transfer such securities within a period of three months after the record date/ sell or transfer such units within a period of nine months after the record date.

Situation 2

• buy or acquire any securities or units within a period of three months prior to the record date;
• earn tax free dividend or income on such securities or unit during the intervening periods; and
• sell or transfer such securities after a period of three months from the record date/ sell or transfer such units after a period of nine months from the record date.

Situation 3

• buy or acquire any securities or units within a period of three months prior to the record date;
• no tax free dividend or income on such securities or unit is earned during the intervening periods; and
• sell or transfer such securities within a period of three months after the record date/ sell or transfer such units within a period of nine months after the record date.

Section 94 covers holding of securities/units both as capital assets and as stock in trade and hence section 94(7) would be applicable to both an investor and a trader of securities/units.

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