Bonus Stripping Under Income Tax

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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 –

  1. The taxpayer purchases or acquires units within a period of three months before the record date,
  2. The taxpayer has received/allotted additional units, without any payment, on the basis of holding of such units on the record date; and
  3. 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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