Dividend Stripping

I came across a concept called dividend stripping. It really is an interesting and good concept to reduce the tax paid on the capital gain. I want to know how it is helpful in present budget terms. Please also tell me the different taxes to be paid (in percentages).
- Bhaskar P.

Dividend stripping refers to using dividends declared by a mutual fund to lower one's tax liability. If you expect a mutual fund to declare a dividend soon, you can buy its units before the record date. When the fund declares a dividend, the NAV will go down, and that is the amount you will receive as dividend. And when the record date for dividend payment is over, you can sell these units. What you end up with is a capital loss and a dividend. Since dividend paid by equity funds is tax free as compared to 15 per cent you pay on short-term capital gains, the tax liability stands reduced.

However, the benefit of dividend stripping no longer exists according to current tax regulations. Under the revised laws, it has been provided that if an investor were to acquire a unit within a period of three months from the record date and sell or transfer the same within a period of nine months from the record date, then any loss arising from the transaction shall be ignored to the extent that the loss does not exceed the amount of such dividend. Thus, one cannot avail of any tax benefit from dividend stripping.

For equity mutual funds, Long Term Capital Gain is not taxed while Short Term Capital Gain is taxed at 16.99 per cent. For debt, Long Term Capital Gain is taxed at 11.33 per cent (without indexation) or with 22.66 per cent (with indexation) while Short Term Capital Gain is taxed according to the slab rate applicable for the investor.

This article was originally published on February 04, 2009.