Bonus Stripping Under Income Tax

Bonus stripping is a strategy adopted for reducing the tax burden under the Income Tax Act. Under a bonus stripping arrangement, the person who wishes for a reduction of the tax burden applicable to his assessment purchases stocks prior to the record date and sells off the units after the record date, when the unit price becomes ex-bonus. As the person is holding the units as on the record date, the person would be eligible for additional units declared by the company, without payment of any additional amount. Due to bonus stripping, the person can get a dual benefit: one, he gets additional units without payment of any additional amount, since he is holding the units as on the record date, and two, since the person sells off the units after the record date at an ex-bonus price, the loss incurred on the sale of the units can be set-off or carried forward, resulting in a loss of revenue to the Government. To overcome the revenue loss, the Government introduced the provisions of section 94(8) under the income tax legislation. The present article highlights the conditions which are mandatory for the imposition of the provisions of section 94(8) and the applicable consequences in case the provisions of section 94(8) are made applicable.

Conditions To Be Fulfilled

In order to impose the provisions of Section 94(8) of the

Income Tax Act, it is mandatory that the following conditions are satisfied -

The taxpayer purchases or acquires units within a period of three months before the record date,
The taxpayer has received/allotted additional units, without any payment, on the basis of holding of such units on the record date; and
The taxpayer sells/transfers original units within a period of 9 months after the record date and holds the additional units.

It must be noted here that ‘record date’, as mentioned above, means the date as fixed by the company for the purpose of entitlement of the holder of the unit to receive income or additional unit without any payment/consideration.

Tax Position In Case Section 94(8) is Applicable

If the above-mentioned conditions of Section 94(8) are satisfied and provisions of Section 94(8) are applicable, then, in such case the loss arising on account of sale of all or any such units shall be ignored for the purpose of computing income chargeable to Income Tax of the respective person. Taxpayers should note that loss ignored shall be assumed to be the cost of acquisition of such additional unit held by the person as on the date of such sale/transfer.

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Frequently Asked Questions

Common questions about Bonus Stripping and Section 94(8) Tax Implications.

Bonus stripping is a strategy adopted by taxpayers to reduce their tax burden under the Income Tax Act. It involves purchasing stocks before the record date, receiving additional units as a bonus, and then selling the original units after the record date at an ex-bonus price to claim a loss for tax purposes.

For Section 94(8) to be applicable, three conditions must be met: (1) the taxpayer must have purchased or acquired units within three months before the record date, (2) the taxpayer must have received additional units without payment due to holding the units on the record date, and (3) the taxpayer must have sold or transferred the original units within nine months after the record date while still holding the additional units.

If Section 94(8) is applicable, the loss arising from the sale or transfer of the original units will be ignored for the purpose of computing the taxpayer's income chargeable to income tax. The ignored loss will be treated as the cost of acquisition for the additional units held by the taxpayer.

The primary purpose of introducing Section 94(8) was to overcome the revenue loss faced by the government due to bonus stripping arrangements. By ignoring the loss claimed by taxpayers through such arrangements, Section 94(8) aims to prevent the resulting loss of revenue to the government.

The record date is the date fixed by the company for determining the entitlement of unitholders to receive income or additional units without any payment or consideration. Holding units on the record date is a crucial aspect of bonus stripping, as it allows the taxpayer to receive additional units without payment.

No, the loss ignored under Section 94(8) cannot be carried forward. The ignored loss is treated as the cost of acquisition for the additional units held by the taxpayer as on the date of sale or transfer of the original units.

While bonus stripping itself is not illegal, Section 94(8) was introduced to counter the tax avoidance resulting from such arrangements. By ignoring the loss claimed through bonus stripping, the provision aims to prevent the misuse of this strategy for reducing the tax burden.

Section 94(8) is applicable to any units or stocks that meet the conditions specified in the provision, regardless of the type of security or the industry in which the company operates.

No, the provisions of Section 94(8) do not depend on the holding period of the additional units. As long as the taxpayer holds the additional units on the date of sale or transfer of the original units, and the other conditions are met, Section 94(8) will be applicable.

The three-month period before the record date and the nine-month period after the record date are specified to identify transactions that are likely to be part of a bonus stripping arrangement. These time frames are designed to capture the typical timeframe within which such arrangements are executed.