Ruling on legality of "Dividend Stripping" Transactions
The Income Tax Appellate Tribunal ("ITAT"), Mumbai, in a recent ruling in the case of Wallfort Shares & Stock Brokers Ltd. v. Income Tax Officer (for assessment years 2001-02 and 2000-01), held that mere knowledge of "dividend stripping" in a transaction does not render it to be a tax avoidance strategy, so long as the transactions between the parties take place at arm's length and the parties act in the ordinary course of their business. Further, the ITAT upheld the tax payer's right to set off losses from such transactions against income chargeable to tax.
In this case, the taxpayer company, (i.e., assessee), was a member of Mumbai Stock Exchange and traded in shares. The assessee claimed that it had incurred loss in the aforesaid transaction in the normal course of its business and, therefore, the loss should be treated as "business loss" and should be set off against income chargeable to tax.
The tax officer held that this transaction was a "dividend stripping" transaction wherein, shares were purchased cum - dividend, and after dividend was received, shares were sold ex-dividend. In the instant case, resultant loss was set off against other taxable income. The assessing officer further held that the assessee had entered into a pre-meditated arrangement with the mutual fund with the sole purpose of avoidance of tax and there was no commercial purpose whatsoever and hence, it cannot be treated as "business loss".
The assessee filed an appeal before the CIT (Appeals) who also held that the loss claimed by the assessee should be ignored as there was no commercial purpose involved in the transaction and the motive or intention of the assessee for entering into the transaction in question was tax avoidance. When the matter came up before the ITAT (Mumbai), the following three questions emanating from the dispute were considered - (a) Whether the transaction was a business transaction, (b) Whether the loss incurred by the assessee on purchase and sale of units of mutual fund is allowable, and (c) Whether the provisions of section 94(7) of the Income Tax Act, 1961 ("ITA"), can be interpreted as retrospective in operation and if so, its effect?
This ruling will give relief to several tax payers who were wrongfully denied losses arising from "dividend stripping" even prior to the year in which the provisions were amended to provide for a minimum holding period, under the guise of 'tax avoidance'.
Source: I.T.A.No.2307 (Mum) / 2004.