SC to decide on 'dividend stripping' by mutual funds

NEW DELHI: The Supreme Court will decide whether mutual fund brokers can resort to a process (dividend stripping) of creating a short-term loss to avoid tax.

A Bench headed by Justice S H Kapadia has issued notice broking firms on a batch of petitions filed by the income-tax department challenging the Bombay High Court judgment that a broker was entitled to have his/her loss set off against income from any other transaction or source.

Dividend stripping happens when a mutual fund declares a tax-free dividend for unit-holders, who after taking the dividend exit the scheme. The net asset value of the scheme declines and unit-holders are able to show a capital loss. As a result, the exchequer misses a chance to tax capital gains.

However, the unit-holder gets the dividend and the mutual fund earns the entry and exit load.

According to the petition, these agents resort to dividend stripping as they know that after the dividend is declared, the net asset value (NAV) of the MF decreases.

Brokers purchase units at a higher price and sell them immediately after the declaration of dividend, knowing that the sale of such units would result in a loss, which they could adjust against the profits derived from the sale and purchase of shares and securities, it added.