Dividend Stripping – Avoidance or evasion?
The judgement of the Special Bench of ITAT we are carrying today is a masterly dissection on interpretation of law, especially when the conflict is between assumed noble intentions of law and blunt meanings of words used to convey the law. What the law allows, the lawmen are not always prepared to concede for the lawmen often think with their hearts while the assessee (or rather his consultant) uses his head.
It may look ridiculous to a layman that somebody will buy units only for selling them at a loss to claim deduction of that loss for computing Income tax. Of course there is the dividend which is not taxable.
Mutual Funds give wide publicity to their proposed dividend. You can buy the units on the record date and sell it the next day and still collect your tax-free dividend. The icing on the cake is you can claim the loss in selling the units as deduction from Income without showing the dividend as income. Too good to be true! But that is the law!
Is the transaction colourable? Is it avoidance or evasion? The Special Bench of the Tribunal in an exhaustive scholarly judgement held that the assessee is eligible for both the benefits as per law.
Incidentally the Income Tax Act was amended in 2001 to control this instant profit and loss activity. As per Section 94(7) inserted in 2001, loss will not be allowed if the units are bought within three months before the record date and sold before three months after and if there is a dividend or income. One of the questions before the Tribunal was whether this amendment had retrospective validity.
There is another aspect to this issue which is not covered in the judgement.
The 2001 amendment did not take into consideration all possibilities. The 2001 amendment which brought in Section 94 (7) to the Income Tax Act dealt with the dividend or income from the mutual fund which is exempted. Now to circumvent this provision, mutual funds can issue bonus units instead of giving income or dividend. Now an experienced stripper can collect these bogus (not a spelling mistake) units and sell the original units he had with him at a loss and claim the loss in computing his income. This is not a figment of imagination from the fertile mind of a Tax consultant but obviously this has actually happened and to rectify this, government has further amended Section 94 and brought in sub-Section (8) to disallow the loss in selling of the units when additional units are allotted. Law making is a big match between the makers and the sufferers – Who wins ultimately? (Consultants)
DDT strongly suggests that you should read this classic judgement for a deep appreciation of the concept of avoidance and evasion. While on that we also suggest you have a glance at this article TAX AVOIDANCE VS TAX EVASION!