Dividend Stripping

Others 1373 views 1 replies

DEAR FRIENDS AND SENIORS, 

TODAY I WOULD LIKE TO FAMILIARISE YOU WITH A TERM DIVIDEND STRIPPING

 

Dividend stripping is the purchase of shares just before a dividend is paid, and the sale of those shares after that payment, i.e. when they go ex-dividend.

This may be done either by an ordinary investor as an investment strategy, or by a company's owners or associates as a tax avoidance strategy.

 

USES

 

For an investor dividend stripping provides dividend income, and a capital loss when the shares fall in value (in normal circumstances) on going ex-dividend. This may be profitable if the income is greater than the loss, or if the tax treatment of the two gives an advantage.

Different tax circumstances of different investors is a factor. A tax advantage available to everyone would be expected to show up in the ex-dividend price fall. But an advantage available only to a limited set of investors might not.

In any case the amount of profit on such a transaction is usually small, meaning that it may not be worthwhile after brokerage fees, the risk of holding shares overnight, the market spread, or possible slippage if the market lacks liquidity.



TAX AVOIDANCE

 

Dividend stripping as a tax avoidance scheme works to distribute a company's profits to its owners as a capital sum, instead of a dividend. The purpose is generally that capital gains may be subject to less tax.

As a basic example, consider a company called ProfCo wishing to distribute RsX, with the help of a stripper called StripperCo.

1. StripperCo buys ProfCo shares from their present owners forX+Y.
2. ProfCo pays a dividend ofX to StripperCo.
3. StripperCo sells its shares back to the owners for $Y.

The net effect for the owners is anX capital gain. The net effect for StripperCo is nothing, the dividend it receives is income, and its loss on the share trading is a deduction. StripperCo might need to be in the business of share trading to get such a deduction (i.e. treating shares as merchandise instead of capital assets).

Many variations are possible:

  • StripperCo might buy different "class B" shares in ProfCo for just the $X amount, not the whole of ProfCo.
  • Such class B shares could have their rights changed by ProfCo, rendering them worthless, instead of StripperCo selling them back.
  • ProfCo might lend money to StripperCo for the transaction, instead of the latter needing bridging finance.

The tax treatment for each party in an exercise like this will vary from country to country. The operation may well be caught at some point by tax laws, and/or provide no benefit.



https://www.moneycontrol.com/stock-charts/smartlinknetworksystems/charts/SNS01



This link is a valid example of dividend stripping

Replies (1)

 

FOR MUTUAL FUNDS


Dividends can be used to lower your tax liability. The proportion of tax you can save though is lower than it used to be previously and now comes with a caveat. Nevertheless the method is still useful. Let us explain how it works. Suppose 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 taxed only at 10 per cent (till March 31, 2003)—far lower than the 30 per cent you are likely to pay otherwise—the entire exercise will reduce your tax liability.

Here's a detailed illustration of how this works. Suppose you have a short-term capital gain of Rs 2 lakh during the current year and if you don't do any tax planning, you would pay approximately Rs 60,000 as tax. Alternatively, you could invest this sum in a fund that has an NAV of Rs 20, and declares a dividend of 50 per cent. This means that for each unit, investors receive Rs 5 as dividend and the NAV goes down to Rs 15. For your Rs 2-lakh investment, you get Rs 50,000 as dividend. However, on the capital account, your investment of Rs 2 lakh is now reduced to Rs 1.5 lakh—a loss of Rs 50,000. Let us see how this affects an individual's tax liability. The amount of capital loss that you suffered in the second transaction will now reduce your original short-term capital gain of Rs 2 lakh to Rs 1.5 lakh. The tax liability on this amount will be Rs 45,000. In addition, you will have to pay a 10 per cent tax on the Rs 50,000 you received as dividend. Thus, your total tax liability is down from Rs 60,000 to Rs 50,000—a healthy saving of 16.67 per cent.


CCI Pro

Leave a Reply

Your are not logged in . Please login to post replies

Click here to Login / Register