Dividend Stripping is a strategy to reduce the tax liability under the preview of tax law. It refers to the activity of buying and selling of securities or units within before/after time of record date of dividend paid. It is applicable mainly in direct equities and mutual funds.

Income tax Guidelines for Dividend Stripping;

For Direct Equity:
Section 94(7) of income tax act says that 3 conditions should satisfy while exercising dividend stripping option to avoid the tax.

  1. The purchase has been made within three month before the record date of dividend.
  2. The Sell should have been made within the three month after the dividend record date.
  3. The losses on the sale should not exceed the dividend income exempted.

For Mutual Fund Units:
Section 94(7) of income tax act says that 3 conditions should satisfy while exercising dividend stripping option to avoid the tax.

  1. The Purchase has been made within three months before the record date of dividend.
  2. The Sell should have been made within the nine months after the dividend record date.
  3. The losses on the sale should not exceed the dividend income exempted.

Example: Let us understand the above technicality with a simple example. Say, if you have invested in mutual fund dividend option on 1st July 2011 of Rs. 1,00,000 with NAV Rs. 50 (you get 2,000 units in total). On 25th August 2011 this gives dividend of 20% i.e. Rs. 10 per unit, meanwhile the NAV at which it was purchased was increased to Rs. 55. As you know whenever dividend is declared the NAV also will goes down to the extent of dividend price. Here your actual NAV i.e. Rs.55 will go down by Rs. 10 to Rs. 45. So if you sell the complete units you may will incur a capital loss of Rs. 10,000 [(2,000 x Rs. 50)-(2,000 x Rs. 45)].

Loss amount can be set of against your other short term gains subject to the loss amount is more than the Dividend received amount, but to the extend of Short Term Capital Loss.

For investors in shares, dividend stripping provides dividend income, and a capital loss when the shares fall in value on going ex-dividend (A security becomes ex-dividend on the ex-dividend date, which is usually two business days before the record date set by the company issuing the dividend). This may be profitable if the income is greater than the loss, or if the tax treatment of the two gives an advantage.

Note: All these transactions should satisfy the income tax law conditions as mention in beginning of article.

What is Dividend Stripping & how does it work?

4 thoughts on “What is Dividend Stripping & how does it work?

  • June 7, 2013 at 9:56 AM
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    Its very clear and informative. I got it very well.

    Thanks…

    Reply
    • June 7, 2013 at 2:44 PM
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      Most welcome Prasanna.

      Reply
  • December 24, 2013 at 9:56 AM
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    This is very informative and practically useful.
    Thank you

    Reply
    • December 24, 2013 at 10:14 AM
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      You are most welcome Venkata!

      Reply

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