Bonus stripping is another similar strategy of buying the units of a fund with an intent to earn bonus units and subsequently selling original units at reduced prices.
By Chirag Nangia
In order to tackle tax avoidance, improve the coherence of tax rules and ensure a more transparent tax environment, governments across the world have legislated General Anti-Avoidance Regulations (GAAR) in their respective domestic tax codes and also strengthened their existing codes by way of 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 securities and units of mutual fund which include dividend stripping and bonus stripping.
Dividend stripping strategy was largely used to reduce the tax burden wherein an investor would invest in securities (including units), shortly before the record date, i.e. date on which dividend is declared, and sell after the record date at a lower price, thereby incurring a short-term capital loss. This short-term capital loss would anyway get compensated by the tax-free dividend under the erstwhile dividend tax regime.
To preclude such an arrangement, Section 94(7) stipulates that any loss arising on account of such purchase and sale of securities or unit, to the extent such loss does not exceed the amount of exempt dividend or income received on such securities or unit, shall be ignored for the purposes of computing the income chargeable to tax. Pertinently, this provision continues to exist even after the promulgation of new dividend taxation regime wherein dividend is taxable in the hands of the shareholders.
Bonus stripping is another similar strategy of buying the units of a fund with an intent to earn bonus units and subsequently selling original units at reduced prices. To quell the practice of bonus stripping, Section 94(8) stipulates that loss, if incurred, would not be allowed to be claimed in the computation of income when units are sold within a period of nine months.
Currently, bonus stripping undertaken for securities, units of Infrastructure Investment Trust (InvIT) or Real Estate Investment Trust (REIT) or Alternative Investment Funds (AIFs) is not within the ambit of Section 94. Also, provisions pertaining to dividend stripping are not applicable to the units of new pooled investment vehicles such as InvIT or REIT or AIFs. The Finance Bill 2022, however, proposes to make certain amendments so as to subject the foregoing anti-avoidance provisions of Section 94.
Interplay between GAAR and SAAR
The Indian Tax Code has always had SAAR. These rules target specific ‘known’ arrangements of tax avoidance. More recently, GAAR provisions have been incorporated under Chapter X-A of the Act and made applicable from 1 April 2017. These provisions have an overriding effect on the other provisions of the Act and grant an unfettered power to the revenue authorities to question transactions and arrangements.
The proposal of Finance Bill 2022 to widen the scope of Section 94(7)/(8) makes one contemplate the need of such a specific provision when GAAR is now in place.
The Central Board of Direct Taxes (CBDT) has clarified provisions of GAAR and SAAR will co-exist and apply, as required, based on the circumstances of a case. While it has clarified that GAAR and SAAR will operate simultaneously, several courts have held that specific provisions override the general provisions. Therefore, the courts may hold GAAR and SAAR to be mutually exclusive, in light of the factual matrix of a case.
The writer is director, Nangia Andersen India. Inputs from Paridhi Sen.
