1. What is Dividend Stripping?
Dividend stripping is a tax avoidance arrangement where an investor buys units of a mutual fund (or shares) just before a dividend/income distribution, collects the dividend (tax-free or at lower rate), and then sells the units at a lower price (since NAV drops after dividend payout) — claiming a capital loss to set off against other capital gains. The net result: tax-free dividend income + artificial capital loss to offset taxable gains.
2. Section 107: Anti-Avoidance for Dividend Stripping
To prevent this, Section 107 of ITA 2025 disallows capital losses arising from dividend stripping:
- If an investor buys units/shares within 3 months before the record date for dividend AND sells within 9 months after the record date
- AND the sale price is lower than the purchase price
- THEN the capital loss (to the extent of dividend received) is disallowed — it cannot be set off against capital gains
The disallowed loss is not permanently lost — it is notionally added back to the cost of acquisition and can be used if the unit/share is held long enough for a genuine capital loss.
3. Example: Dividend Stripping Blocked
Illustrative only. Ram buys 1,000 units of a mutual fund at Rs 50/unit (total Rs 50,000) on 1 June 2026. The fund declares a Rs 5/unit dividend on 15 June 2026 (record date). Ram receives Rs 5,000 dividend. After dividend, NAV drops to Rs 45/unit. Ram sells on 15 October 2026 at Rs 45/unit (total Rs 45,000) — capital loss of Rs 5,000.
Under Section 107: Ram bought within 3 months before record date and sold within 9 months after — dividend stripping applies. The capital loss of Rs 5,000 (equal to dividend received) is DISALLOWED. Ram cannot set off this loss against other capital gains.
4. What is Bonus Stripping?
Bonus stripping is similar — an investor buys units before a bonus issue, receives bonus units (additional units at zero cost), and then sells the original units at a loss (since NAV adjusts downward after bonus) while holding the bonus units long-term for LTCG benefits.
5. Section 108: Anti-Avoidance for Bonus Stripping
Section 108 blocks bonus stripping:
- If an investor buys units within 3 months before the record date for bonus AND sells original units within 9 months after the bonus
- The capital loss on original units is disallowed to the extent of bonus units received
- The disallowed loss is added to the cost of acquisition of the bonus units
6. Why These Provisions Exist
Before Sections 107/108, dividend and bonus stripping were widely used tax planning strategies — particularly with mutual funds that distributed large dividends. IDCW (Income Distribution cum Capital Withdrawal) mutual fund options were structured specifically around these strategies. Sections 107/108 closed these loopholes, making genuine long-term investment the only way to benefit from mutual fund returns efficiently.
7. Impact on IDCW Mutual Fund Investors
Regular investors in IDCW (dividend) option mutual funds are NOT affected by Section 107 as long as they do not sell within 9 months after the dividend record date. The provision targets only deliberate dividend stripping — buying just before dividend and selling immediately after. Long-term IDCW investors who hold for years are not affected.
8. Why TaxClue
Inadvertent dividend stripping disallowances can catch investors by surprise — especially in volatile markets where short-term selling occurs. TaxClue identifies potential Section 107/108 triggers in your portfolio before year-end. Contact us for mutual fund taxation advisory under ITA 2025.