Big investors have spotted a unique opportunity to increase their returns from the market. With a large number of mutual funds announcing hefty dividends, smart investors are back at the game of dividend stripping to reduce tax liabilities.
Dividends are tax free in the hands of investors, but these unitholders rush to book capital losses immediately after the dividend is paid.
Dividend stripping pertains to investing in schemes before the dividend record date for a few days and booking a capital loss when exiting. Done to offset the capital loss against other capital gains and to get a tax-free dividend (where funds have more than 50 per cent in equity).
Since the net asset value of the fund falls after distribution of dividends, these unit holders encash their units at a lower price, and book capital losses which they can legitimately set off against capital gains elsewhere.
The yields on their investments thus increases manifold, depending on the applicability of tax rates for the investor.
Interestingly, the net asset value of around 18 funds has fallen by between 25 per cent to 55 per cent in the last one month, after these funds announced huge dividends.
The practice of dividend stripping was rampant in bond funds which lured investors with huge dividends. But, with a booming equity market, the practice has spilled over to equity funds too.
With dividend stripping, investors save on the tax payable on short-term capital gains by offsetting it with a short-term loss on the mutual fund investment.
First, the investor pockets the dividend on which he pays no tax.
Further, once the dividend is paid, the net asset value of the fund immediately depreciates to account for the outflow of funds from it. This leads to a capital loss for the investor.
However, the investor adjusts this against certain capital gains made in separate transactions and saves tax which he would have otherwise would have to pay.
The 91-day lock-in period is mandatory for an investor to claim tax benefits from the dividend stripping game.
Also, investor adjusts this against certain capital gains made in separate transactions and saves tax which he would have otherwise had to pay.
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